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Will a child maintenance trust save you tax? Yes but it comes at a cost.
Child Maintenance Trust
How does a child maintenance trust work and save you tax? And why – despite the huge tax savings you can achieve with them – why are they so unpopular?
In this episode – published on 31 August 2021 – child support lawyer Simon Bacon of Manby & Scott in Melbourne will give you an answer to these questions.
Here is what we learned but please listen in as Simon explains all this much better than we ever could.
To listen while you drive, walk or work, just access the episode through a free podcast app on your mobile phone.
Child Maintenance Trust
The main purpose of a child maintenance trust is to save tax. And it does. But this tax saving comes at a high cost. Here is why.
Saving Tax
Let’s say you have two children and have agreed or been ordered to pay $20,000 for each child per year, so $40,000 per year. You are in the top marginal tax rate, so to pay $40k a year after tax, you have to earn (roughly) $80k before tax. A fair bit of money.
To avoid this you move the required capital ($0.8m at a 5% return) into a child maintenance trust that can then distribute the investment income to your children as excepted income (so the punitive rates for minors per Div 6AA ITAA36 don’t apply).
So now the trust only needs to earn $40k in income to pay the child support and not $80k. And if your children have no other income, they pay zero tax on the $20k they each receive from you.
You save almost $40k in tax each year. Sounds really good, doesn’t it? But this tax saving comes with two huge disadvantages.
1 – Loss of Capital
You sustain a huge loss of capital. You have to hand over $0.8m to the trust to save $40k tax each year. These $0.8m are gone. Unlikely that you ever see that money again. They will go to your children at vesting.
2 – Loss of Leverage
If you are the paying parent, you have one draw card to secure regular access to your children (apart from going to court): Regular payments.
By handing over all of the money in one go, you lose that leverage.
If you are denied access to your children, you could – in theory – retaliate by not paying out trust distributions, but then you have unpaid present entitlements (UPEs) within the trust. And that is a whole other issue.
But if you are certain that access to your children won’t be an issue, then you might trade a child maintenance trust against lower ongoing payments.
So you might agree on $10k per year per child instead of $20k and for that, you hand over $0.4m in capital to the trust and not $0.8m.
Trustee
Usually, it is the paying parent who is the individual trustee or director of the corporate trustee of the child maintenance trust.
However, if you have a child support agreement, you can agree on whatever you want. You could agree that the receiving parent is the trustee or director.
Agreement v Assessment v Court Order
You can use a child maintenance trust for any child support obligation, be it from a child support agreement, a child support assessment or a court order for child support. That is not the issue. The issue with the loss of capital and leverage.
Trust Distribution
Could – and this is a question – could you distribute income from a family trust to a child maintenance trust and then to the child as excepted income?
You can’t. TR 98/4 explicitly excludes the scenario where you have your family trust distribute income into the CMT without moving assets into the CMT.
Bucket Company
What about moving assets into the CMT where you can somehow control how much income these assets derive? In other words, you move the shares to a bucket company into the CMT.
Unfortunately TR 98/4 explicitly blocks such a set-up as scenario 4 as well.
Summary
Child maintenance trusts are a lot less common nowadays due to the loss of capital and leverage they entail.
When we asked around in preparation for this episode among family law lawyers and tax lawyers, we got a lot of No’s that sounded like this,
“No sorry, we used to do them but not anymore – haven’t done any for many years.”
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Disclaimer: Tax Talks does not provide financial or tax advice. All information on Tax Talks is of a general nature only and might no longer be up to date or correct. You should seek professional accredited tax and financial advice when considering whether the information is suitable to your or your client’s circumstances.
Last Updated on 23 October 2023
Tax Talks spoke to Simon Bacon - Partner at Manby & Scott - for more details.
