Legal Tip 286: Child Maintenance Trusts

A child maintenance trust (CMT) is a trust set up as part of a breakdown in a relationship. The trust is set up to benefit the children of the relationship. But it can benefit the whole family because the minor children can be taxed as adults on the income of the trust. if they receive income it will be taxed at adult tax rates under s102AG ITAA36


This is very similar to the way children are taxed with income from testamentary trusts


These trusts work like this

One or both parents gift assets to the trustee of a discretionary trust – the trust must be set up in a way so that upon vesting the capital of the trust passes to the children of that trust. Other beneficiaries of the trust can benefit from the income, but only children from the capital.


The income from the trust can satisfy any maintenance orders from the court.


Example

Homer and Marge separate and there is a court order that Homer pays Marge $20,000 per year.

Homer and Marge have 3 children.

If Homer pays Marge $20,000 p.a. he would need to earn about $40,000, pay half in tax to be left with $20k



Instead Homer sets up a CMT with a settlor who begins the trust with $10. Homer then gifts $300,000 cash he has to the trust. This is invested and $20,000 earned per year.

This is distributed to the children who pay no tax on it.

You might think Homer is giving away $300k, but he is basically saving $20k per year for as long as the children are under 18.

After the children all become 18 the trust can still be kept going, or it can be wound up with the kids getting $100k each. They might then give this back to their father, (or they may blow it).

 

Fat chance of that happening.

 

Hi Terry,

Could Homer set up his own discretionary trust to put the 300k and invest it and then distribute 20k a year to the CMT? That way he retains the 300k capital but also satisfies the maintenance for the kids?

cheers,

 

Homer could, but would the kids be taxed as adults? Prob not

 

Hmm ok, so the capital would need to be in the CMT trust rather than the CMT trust just receive a distribution in to get the kids onto adult tax rates?
That makes sense!

 

Yes the income would need to be generated from capital transferred to the trust. But there are a lot of strategies to consider.

 

Can a s102AG trust reinvest, say, dividends generated from initial capital, such that:

1) there is a upe to the minor beneficiary and

2) the income from the reinvested dividends retains its s102AG nature (minor taxable as adult)?

so if there is a testamentary trust, can the trust keep retaining income in the trust to compound without paying out cash to beneficiaries?

 

Yes I think so, there is the option for the trustee to be taxed on behalf of the child too - this can work with will trusts but not sure of CMTs.