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Raising kids is an expensive business. And things can become even more expensive if you have been involved in a family breakdown.
Are you paying child support or maintenance?
A Child Maintenance Trust may be the answer.
A Child Maintenance Trust (CMT) is a legal structure that allows payments on behalf of your children.
A CMT holds assets for the benefit of your children. Income created from the trust property can be paid to you children (or their guardian) to cover maintenance.
Your children can access the trust funds when they reach “vesting age”.
You can set up a CMT if you have been involved in a family breakdown and you have legal obligations to pay maintenance to (or on behalf of) your children.
The Income Tax Assessment Act defines a “family breakdown” in broad terms. A “family breakdown” generally relates to the end of a domestic relationship (such as marriage or de facto relationship).
You do not necessarily need to be divorced to be in a family breakdown – you may just be separated.
A CMT can also apply where children are born outside a domestic relationship.
Both parents have to agree to the CMT. This is usually negotiated as part of an overall property settlement between the ex-partners.
To receive the tax benefits of a CMT, the payments must be required to be made as the result of a court or administrative order.
For many people, a CMT is a tax-effective way to pay child support.
If your children are minors (ie: under 18) and are not in full time employment, they will have a much lower tax-free threshold than you. And they will not have access to the graduated marginal tax rates that adults enjoy.
This means your children will be taxed at the top marginal tax rate for any income apart from wages (such as interest, dividends and payments from a trust).
But, if payments are made through a CMT, the income is classed as “exempted trust income” for the purposes of the Income Tax Assessment Act 1997 . This means the trust income is taxed at the same rate, and with the same tax-free threshold as adult income.
A CMT is also a good way to set aside assets for your children. That way you can make sure your children will be provided for, even though your family has broken down. This kind of arrangement means that all parties are clear about the financial support you will provide your children.
The trust assets are also protected from external creditors if you become bankrupt.
You may also be able to use the trust assets for commercial purposes, as long as the arrangements are entered into on an “arm's length” basis. That is, you cannot invest a small amount of funds to derive a large income flow.
The Commissioner of Taxation will assess the income derived from CMT arrangements. If the trust is not administered correctly, the trust income may not receive the tax benefits you planned for.
You should speak to your lawyer and financial advisor before considering the investment of trust funds.
Currently, a minor who is not in full time employment can only earn $416 before their income is taxed. Every non-employment dollar they earn over $416 will be taxed at a whopping 48.5% (including the Medicare Levy).
If payments are made through a Child Maintenance Trust, however, your children can earn $6,000 in child support payments before they start paying tax. The remaining income will be taxed in the same graduated way that adult income is taxed. You can make substantial tax savings in this way.
For example, if child support is $15,000 each year without a Child Maintenance Trust, you would have to pay approximately $14,000 in tax. That would make a total of about $29,000 each year. But if the same amount ($15,000) is paid through a Child Maintenance Trust, the tax liability is only approximately $2,000, making a total of about $17,000. In other words, you stand to save $12,000 in tax each year.
If you have obligations to make payments to more than one child, over a number of years, you can make large potential tax savings by using a Child Maintenance Trust.
The initial property settled on a CMT should have a value of at least $300,000.
Therefore, setting up this kind of trust can be of great benefit to you if you earn over $80,000 and hold other assets. The funds settled on the trust can be borrowed, as long as you eventually repay the capital and hold the funds for the benefit of your children.
A CMT will be particularly useful if you are required to pay child maintenance for a number of years. And if you have more than one child, the benefits can be substantial.
It is important that you and your ex-partner both agree on the establishment and functions of the trust. Make sure you get independent legal and financial advice before setting up a CMT. There is a lot of money – and your children's finances – at stake.
At Watson and Watson, we have the experience to guide you through process of setting up a child maintenance trust. That way, even though you have been through a family breakdown, you can rest assured that your children will be provided for. And you'll be glad to know your payments are going to your children, not the taxman.
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