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 bringing the children into a trust arrangement.
There’s no doubt that the breakdown of family relationships is both stressful and expensive, especially if the parent paying child support is finding the funds out of after-tax earnings.
But by looking at restructuring the lead provider’s income and transferring the funds to the children through a trust, people earning in the top marginal tax rates can keep payments high while reducing their tax burden.
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. In other words, when in the proper structures, 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, this is a legal way to structure their affairs so some of the family income is earned in a structure set up 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.
However, there are a number of 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, assessment or agreement in place that require you to pay support for the children.
The client can then transfer property or assets 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.
Among other specific requirements, the tax law requires some property be transferred to a trust for the benefit of your children and that property must ultimately pass to them.
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.
An existing discretionary family trust is not sufficient, but it is possible for professionals to transfer units in a professional practice services trust to a newly established child maintenance trust.
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. It means that everyone is better off, and it becomes much easier for the family to maintain a pre-separation lifestyle.
Geoff Thompson, Partner, Pitcher Partners