Key points on types of assets and divorce
Let’s take a look at various examples of types of assets and how they should be considered in the context of divorce.
By and large, UK- and US-qualified pensions are mutually respected as tax-deferred wrappers. It is not uncommon for the courts to issue a pension sharing order, whereby a pension is split between the two parties. Carefully consider the consequences of having either a pension debit, or a pension credit, and seek relevant advice.
Suppose a British spouse receives part of a US pension, and is not a US person: Care must be taken from an estate planning perspective, given the exposure to US estate taxes on US assets held by non-resident ‘aliens’.
On the UK side, it is important to consider the Lifetime Allowance (LTA) implications of a pension sharing order, especially if the pension has already been crystallised (typically meaning it has been accessed). To those in pension ‘debit’ i.e., ceding away part of their pension, it is important to note the remaining percentage of LTA remaining is what presides, so further top ups (even after the debit) can lead to a Lifetime Allowance charge. On the flip side, the party receiving a pension ‘credit’, i.e., being awarded a share, can apply to extend their LTA via an enhancement factor in certain circumstances, but again advice should be sought.
Investments can take many forms in either the US or the UK. Outside of qualified pensions, it is usually safe to assume that an account with tax advantages in one jurisdiction does not enjoy those same benefits across the pond. Once again, whilst steps can be taken to avoid double taxation, the more punitive tax treatment on a particular asset will usually preside over the friendlier regime.
As a result, regardless of the structures investments are in, it is important that the underlying investments are as efficient as possible in both the US and the UK.
As an example, a collective investment fund in a UK investment account is likely considered a Passive Foreign Investment Company (PFIC) in the US and is aggressively taxed at the hand of a US taxpayer. The equivalent opposite is true, where most US-based funds are much more valuable to a US taxpayer than a British counterpart, given HMRC rules on overseas funds. Put simply, an efficient investment for one party can be a real hospital pass to the other, and understanding these differences is paramount when agreeing how a household’s assets should be split.
The same is true for real estate, although this can be more cumbersome to plan around in practice, given the high percentage of many households’ wealth tied up in their home.
If we look at a couple’s main residence, if this is based in the UK, a US taxpayer may have a larger tax bill than their British counterpart. Under current rules, Britons are not taxed on their main UK-based residence by HMRC under ‘principal primary residence relief’. The US treatment for a US taxpayer is not so generous, and again, once the tax authorities have had their say, it may be that the marital home is worth more to one spouse versus the other.
The US tax treatment of mortgages is also an issue to contend with, especially when that mortgage is based in the UK. Currency fluctuations can give rise to a taxable currency gain in the US on a UK mortgage, even if in Sterling terms, the value of the mortgage has remained flat (or in many cases, reduced, as you might expect after repayments). The challenge of currency fluctuation applies to every type of investment for our clients, but the example of a taxable US Dollar gain on a UK mortgage tends to astound those affected. Therefore, in some circumstances, taking over the marital home and its large mortgage exposes the US person to the potential of nasty surprises.