FAMILY TAX BENEFIT
Tax Free Child Support – Taxing Children
Tax – free child support payments – Taxing children
QUESTION: Brett, over the last few weeks you have spoken about tax-free income under your 3G Testamentary Trust Wills and disabled children. What about us fathers that are paying maintenance with post tax dollars? We earn money and pay tax on that money. We then give what is left to our ex-wives to look after our children. The ex-wives and children earn no income and don’t get to use up their own $6,000 yearly tax – free amount.
ANSWER: Raising children is an expensive business and more so if the parents are separated.
Most maintenance (child support) is paid with after tax dollars. The highest marginal tax rate is 46.5%. If you are on that rate then you need to earn almost $40,000 to have $20,000 left to pay the child support.
A Child Maintenance Trust allows your children to pay the tax but generally at a lower tax rate – even a tax rate of zero. This is tax – effective income splitting.
With such a trust, you hold assets for your children’s benefit. In effect, you put “capital” into the trust (e.g. machinery, livestock, or more rarely shares and property – anything that makes an income). Some or all of the income created from the trust can be paid to your children (or their guardian). This covers your maintenance obligation. The children then pay tax at the generous adult rate threshold. E.g. for each child the first $6,000 is tax – free (as it is for any Australian adult).
Usually, a child under 18 years of age pays tax at a rate of 66% for passive income from a trust. This is not the case for the Child Maintenance Trust. Under the income Tax Assessment Act 1936, the trust income is “expect trust income”. A properly set up Child Maintenance Trust gives the child the more generous adult tax rate threshold.
Sadly, your children eventually get their hands on the capital. This can be when they are 18, 21 or even 80 years from the date that you set the trust up. This date is called the “vesting age”. This is why small business owners are the most prevalent users of these Child Maintenance Trust.
Small business owners can use trust assets for commercial purposes. Obviously, a fair market price has to be paid for use of the trust assets. You can’t put a worthless item into the trust and lease it out for a lot of money to your business.
A farmer can put sheep in to the trust. The jeweller can put a polishing machine in to the trust. The sheep and machine, through a service trust arrangement back to the business, make a lot of income. Thankfully, they are depreciating items. They eventually become worthless. Therefore, after time there is no capital left to give the children.
Conversely, a non – business owner often has to put something appreciating into the trust. This is often shares and property. This means that a lot of capital is tied up in the trust that eventually is handed to the children. An alternative for the non-business owner is to purchase an annuity in the name of the trust.
The trust is only available for a “family breakdown”. You also need a legal obligation to pay maintenance for you children.
A “family breakdown” is the end of a domestic relationship – either a marriage or de facto relationship. There is no requirement to be actually divorced. You don’t have to have been married or in a de facto relationship. A one – night fling will do it.
Both parents must agree to the trust being set up and used. The other parent may not care about saving your tax. In fact, they are often happiest when you are suffering the most.
There are 4 major benefits to explain to the other parent:
1. The trust assets are protected from external creditors if you become bankrupt. If you go bankrupt, your children will end up with a lot less maintenance.
2. There is a guarantee of the assets in the trust, even if you get sick. If you stop work, the assets are still in the trust. There is greater protection.
3. When the time comes for the children to get the asset:
(a) The 50% Capital Gains tax concession is available to the children (as natural persons.
(b) The 50% CGT small business concessions may be available
(c) Before the trust so vests, loans can be made to beneficiaries
4. If worse gets to worse, you can share some of the tax savings with the other partner or give more to the children.
Whether a Child Maintenance Trust is for you is a question for your accountant and adviser to give advice on. They cost money to set up (about $1,100 plus accounting, legal and financial planning fees).