It may be good and well to cope with a disappointment, but it is better to take advantage of it. Death and taxes, so the saying goes, are two of life’s certainties. And for an indeterminate 40% of the married population, so too is divorce. Although death has become less expensive with the abolition of death duties, taxes and divorce remain as expensive as ever (if not more so). Any time is a good time to partake of a little estate planning. Death and divorce are great times to do so—they each present the opportunity to structure assets and income streams. In this month’s post, we’ll discuss one of opportunities in the context of divorce.
Perhaps the most obvious (and often overlooked) area for tax planning the event of divorce concerns child maintenance trusts. These are trusts which differ from the common family discretionary trusts in a number of ways, but most importantly, in the way in which distributions of income to children are taxed.
The general rule is that trust distributions of income to children of more than $416 are taxed at a penalty rate of tax. After allowing for low income tax offsets currently available, the penalty rates commence at an income of about $2,600 per annum. But the Income Tax Assessment Act provides that distributions to children from child maintenance trusts are taxed at ordinary adult beneficiary rates of tax. The savings can be substantial.
For example, assume a parent advances $130,000 to a maintenance trust and it generates an income of 10% per annum on that sum, being $13,000 per annum.
Also assume there are two children who are entitled to a tax-free threshold limit of $6,000.
Since each child would be entitled to the low income tax offset, they would pay no tax.
Assume that the parent was earning income and paying tax at the highest marginal tax rate (ie, at 46.5%). Tax at that rate on the $13,000 equals $6,045.
However, the parent would not pay any tax if the income is distributed by a trustee of a child maintenance trust to the children. For practical purposes the trustee would pay the tax on behalf of the beneficiaries so entitled. There is in effect a tax saving of $6,045 every year. If the amount of capital put into the trust for, say, four children, was $260,000, then the annual tax savings would be $12,090.