Problem:
Kevin and Elizabeth are negotiating a divorce settlement. Kevin is in the 35 percent marginal tax bracket and Elizabeth is in the 15 percent marginal tax bracket. Kevin has offered to pay Elizabeth $15,000 each year for 10 years; payments would cease if Elizabeth dies before the end of the 10-year period. Elizabeth is willing to settle for that amount only if the payments qualify as a tax-free property settlement because she needs at least $15,000 after tax to meet her expenses.
Q1. How much would Elizabeth have to receive in taxable alimony payments from Kevin to have the equivalent of a $15,000 tax-free payment?
Q2. If Kevin agrees to an $18,500 alimony payment, what is the after-tax cash flow for Kevin and Elizabeth? By how much does their cash flow improve over the proposed $15,000 property settlement payment?