In fact, for professionals who find themselves getting a divorce, thinking early about how best to pay child support can see them legally halve the real costs by utilising a properly established child maintenance trust arrangement.
There’s no doubt that the breakdown of family relationships is both stressful and expensive, says Pitcher Partners’ Geoff Thompson, especially as the parent paying child support is paying the funds out of after-tax earnings.
But Mr Thompson says that by looking at restructuring the paying parents’ affairs and possibly transferring the funds to the children through a maintenance trust, people earning in the top marginal tax rates can keep payments high while reducing their tax burden.
The solution lies in transferring assets to the child or children via a trust, rather than just paying child support from personal after-tax earnings, he says.
Income earned from those assets by the children can — in many cases — then be tax free, increasing the funds available to younger members of the family.
“Normally income earned by a child is penalty taxed once it exceeds $416 in a year but in certain circumstances the tax law allows children to the pay the same rates of tax as adults,” Mr Thompson says.
“In other words, structured properly, children of divorced parents can earn the first $18,000 of income tax free and that money can be used to pay the child support.
“For many divorced or separated professionals a legal way to structure their affairs is to transfer units or shares in a professional practice service entity to a new child maintenance trust specifically set up so some of the family income is earned in that structure to provide maintenance for their children. The money earned by this structure can then be used to fund the child support payments as well as other living costs of the child.”
Mr Thompson says there are a number of strict requirements that need to be in place for the arrangements to be considered.
Besides the simple requirements (being a parent of the children and no longer married to your spouse), there must also be a court order, child support assessment or agreement in place that requires you to pay support for the children.
Mr Thompson says the client can then transfer property or assets (often Units in a professional practice service trust) to a trust for the children’s benefit, giving effect to the legal obligation under the order, provided the terms of the trust require your children or their estate to own the assets when the trust ends.
“Amongst other specific requirements the tax law requires some property be transferred for the benefit of your children and that property must ultimately pass to them,” he says. “The income needs to be generated from that property. The issue is deciding what property can we transfer to a trust that you are ultimately happy for your children to keep — and that will generate sufficient income to make the establishment of a trust worthwhile.” “Often parents don’t want to give away valuable capital assets to their children but are happy to hand over units (property) in a service trust which has a nominal value”, he added
An existing discretionary family trust is not sufficient, he says. “I have had professional clients who transferred units in a professional practice services trust to a newly established child maintenance trust and got a positive binding ruling from the Tax office,” Mr Thompson says.
For the family — and the children in particular — the financial benefit can be substantial over the years.
As an example, if a paying parent had three children and the assets in a trust generated $90,000 in income, the total tax payable would be $7,191 compared to $42,300 if the parent was paying child support after tax at the top marginal rate.
“This is a saving of over $35,000 a year or $350,000 over ten years” Mr Thompson says.
“It means that everyone is better off, and it becomes much easier for the family to maintain a pre-separation lifestyle."