CHILD MAINTENANCE TRUSTS

A Child Maintenance Trust is a vehicle that some clients use for paying child support in a tax effective manner.

The principal benefit of using a Child Maintenance Trust is that the financial support provide to a child including periodic child support, educational costs and other financial assistance is taxed in the hands of the child on the basis that the child is able to claim a tax free threshold as if they were an adult. Normally, child support is paid using a parent’s after tax income. If however, the paying parent has income from an asset such as an investment property, that asset can be transferred (usually at the time of property settlement) into a Child Maintenance Trust and the investment income utilised to meet the child support obligation and other support.

This investment income will no longer be considered as part of the paying parent’s income, and as a result they will have a lower individual assessable income whilst still meeting their child support obligations. The only ‘catch’ is that the asset that generates the income in the Child Maintenance Trust must eventually pass on to the children (it cannot be pulled back out and used as an asset of the parent).

Whilst these Child Maintenance Trusts are not for all clients they should be considered by clients who are facing many years of meeting school fees and other expenses for children but have sufficient assets to effectively quarantine an income producing asset to meet the costs for the children during their childhood and tertiary education on the basis that the child will then be entitled to the underlying asset.

The following is an example of the possible tax savings:

Trish and Terry have divorced. Under the terms of their parenting plan Trish has care of Tanya, their 10 year old daughter.

Terry is required to provide maintenance for Tanya’s upbringing of $200 per week plus $15,000 per year for private school fees – a total of $25,400 per annum.

Terry, who is CEO of a large listed company has an annual salary in excess of $250,000 so that he is on the top personal tax rate, which is currently 49%. He also has an investment portfolio of units in property trusts and other managed funds. The value of the portfolio is approximately $500,000 and produces a return of approximately 5.5% per annum – or $27,500.

If Terry does nothing, he will pay tax of $13,475 on the $27,500 investment income, leaving him with $14,025 from his investment earnings. Therefore, he will have to use his after-tax salary to top up the child maintenance payments.

If however Terry transfers the investment portfolio to a properly constituted child maintenance trust, the $27,500 income will be assessed to Tanya at normal adult tax rates (rather than the penalty rates which normally apply if a trust distributes income to a minor). After the low income offset, the tax payable on the income will be $1,322 plus Medicare of $550. Therefore the net-after tax income available for Tanya is $25,628.

The end result for Terry is that he has saved the tax of $13,475 per year which she was otherwise paying on her investment income, which over 8 years (for example) would amount to $107,800.

Note 1: If the investment income included franked dividends the tax payable by Trish would be less, but the tax payable by Tanya would also be less.

Note 2: The transfer of the portfolio may trigger CGT for Trish if the portfolio has an aggregate value greater than its original cost.

We will work with your accountant in the finalisation of your property division and child support arrangements to maximise the tax advantages in each case. Should you not have a trusted financial advisor or accountant, Phillips Family Law is able to provide guidance and recommendations for an appropriate advisor.