Ruth and Pedro have been living separately for 6 months and are in the process of finalising their divorce. After much discussion over finances, they have finally gone to a formal mediator and reached a proposed written agreement which they must sign or escalate to court. Both parties want to avoid going to court due to the cost of doing so. Ruth is an oil pipe engineer and earns $195,000 p.a. and Pedro is an online proof-reader and earns $28,000 p.a. Under the deal, Ruth will transfer the home (permanent residence) to Pedro and pay him a spousal support payment as a one off lumpsum of $150,000. This payment is so Pedro can support himself for the next 5 years. After 5 years, Pedro will be required to support himself. Pedro and Ruth will have shared custody of their child Remi, aged 13. Over a two-week period, Remi will stay at Pedro's house 10 days and 4 days at Ruth's house. Ruth has agreed to pay for all of Remi's expenses and also agreed to pay Pedro Remi's child support of $150 a month for the next 5 years. Ruth's marginal tax rate is 44% and Pedro's tax marginal tax rate is 20%. Assume that marginal tax rates do not change for the purposes of this question. Also, assume a default after-tax rate of return 2% p.a. paid annually. As Ruth's tax advisor, she has sought your help to identify issues with this proposal.

a) Explain to Ruth, with reasons, the tax implications of the current divorce payments and propose an alternative way for Ruth to structure her spousal support payments. Show the tax advantages a new proposal would have for her.

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Ruths spousal support payment of 150000 is considered a lump sum payment and is not taxdeductible A... View the full answer