Key Takeaways
- As you navigate the financial implications of a divorce, keep a careful eye on applicable federal and Pennsylvania state tax law. Doing so will help make sure your own filings are accurate and compliant.
- Find out how alimony, child support, and property division are taxed differently under state and federal law. Make sure you structure your agreement properly to take full advantage of the tax credits and deductions available to you.
- Decide which of the parents can claim the children as dependents. Keeping these rules in mind when deciding who will claim child-related tax credits can make a big difference in your overall tax liability.
- Use Qualified Domestic Relations Orders (QDROs) to divide retirement accounts without incurring taxes or penalties, and always verify compliance with legal requirements.
- Keep detailed records for all support payments, asset transfers, and custody arrangements. This will help substantiate your claims and make filing your taxes much easier.
- Seek professional help to prevent these costly mistakes. These misclassifications, claiming the wrong dependents, and failing to consider the basis rules for separated assets may result in penalties.
Tax deductions and credits related to divorce in Pennsylvania help you keep more of your income when filing state and federal returns after a split. You are entitled to adjustments to your filing status, child tax credits, and potential itemizations such as if your alimony payments were the tax deductible variety.
The IRS and Pennsylvania Department of Revenue both have well-defined rules, so it’s easy to identify what qualifies for each. If you pay or receive child support, you can feel the impact on your taxable income in real dollars.
If you have a home, or divide assets with capital gains, there are tax and property tax implications. Each piece is important in determining your annual return.
Finally, you’ll look at how these tax changes play out, line by line. This will allow you to take the best financial approach in future tax years.
Navigating Federal vs. PA Rules
Divorce often means major life changes, and filing taxes in Pennsylvania after a divorce can be complicated. Navigating federal versus PA rules is crucial because federal tax laws and state rules go hand-in-hand, but they aren’t always aligned. For instance, when you calculate your federal adjusted gross income, you may apply various deductions or exemptions.
Pennsylvania frequently doesn’t allow you to claim those same deductions when calculating your PA taxable income. So, if you’re used to certain write-offs on your federal return, you might not get that break with the state. State-specific rules have an outsized impact on your tax bill, more than most people realize.
If you pay income or wage taxes in another state, you are prohibited from claiming a resident credit for those taxes paid to Pennsylvania. This is only true if the income stems from Pennsylvania sources or adheres to their sourcing guidelines. This can be very surprising if one has lived and/or worked in their former state prior to or during the marriage dissolution.
Yet Pennsylvania imposes a cap on the amount of credit you can claim. So, if you owe $4,000, but get a $3,000 resident credit, you can apply only the last $1,000. Enter this amount on Line 8, PA-40 Schedule OC.
After federal credits are passed through business or investment holdings, too. Shareholders that receive credits from a PA-20S/PA-65 Schedule RK-1 must place those on PA-40 Schedule G-L. With most tax credits, you can simply use the credit to wipe out your entire tax liability.
Just don’t forget to take off any nonrefundable credits you’ve claimed so far. If you have an ABLE account, Pennsylvania lets you deduct contributions up to the federal gift tax exclusion each year. Aligning your federal and PA filings is essential. It saves you from leaving significant credits on the table and from time-consuming delays due to errors.
Alimony and Spousal Support Taxes
Taxes on alimony changed a lot in recent years, and you need to know both federal and state rules if you’re dealing with divorce in Pennsylvania. How you handle alimony will affect your taxes for years to come. That means both ways you pay as well as ways you declare your payments.
It is so much more than the money you’re paying or receiving. How you structure it, record it, and report it can affect your financial situation years after the divorce decree is signed.
1. Understand Federal Alimony Tax Law
Prior to 2019, people who paid alimony received a tax deduction on the payments they made. On the flipside, people who were receiving alimony were forced to claim it as taxable income. However, ever since January 1, 2019, that has no longer been true.
Now, alimony isn’t deductible by the payer and is no longer reported by the recipient as taxable income. If you change an old agreement after 2018, new tax rules can kick in, so it’s smart to check before you sign. Prior to 2019, that was a welcome tax break to the majority of people who paid alimony—about 37% of taxpayers. Unfortunately, this benefit is not available for new cases.
2. Know Pennsylvania’s Support Treatment
Pennsylvania’s courts determine spousal support according to their own court’s rules. When the court determines support, the payer’s net income decreases for calculating other costs. State law lines up with federal law now: support isn’t taxed for either side.
When negotiating support, knowing the rules is incredibly important. They affect your net income and allow you to engage in advanced payment planning.
3. Differentiate Alimony vs. Child Support
Alimony and child support are treated very differently for tax purposes under the new tax code. For divorcing couples, child support isn’t taxed or deducted for anyone, which can impact the finances of both the receiving spouse and the paying spouse.
4. Structure Payments for Tax Clarity
Monthly payments in a separation agreement will require some form of documentation to help facilitate record-keeping. Putting everything in writing will save divorcing couples a headache down the road.
5. Document Support Agreements Properly
Document each payment, modification, and retroactive order in detail. Knowing who’s responsible for what and when in the divorce decree reduces confusion at tax time.
It gives you documentation in case the IRS does come knocking and asking for documentation.
6. Report Payments/Receipts Correctly
Issue each payment exactly as specified in your settlement agreement or court order to avoid tax issues, especially regarding marital property. Maintaining thorough records is key for both parties to stay informed.
Claiming Child-Related Tax Benefits
After a Pennsylvania divorce, you might get to claim tax benefits for your children. These benefits encompass credits and deductions such as the Child Tax Credit, the Child and Dependent Care Credit, and education credits. You juggle complex custody and support agreements with active partners or exes.
The decisions you make have a huge effect on how much you’ll pay in taxes. Custody and support arrangements determine who can claim which benefits, so it’s best to understand the rules before tax season arrives.
Who Claims the Children?
The parent who has the child most nights in the year—called the custodial parent—gets to claim the child on taxes. Only one parent can claim the child each year. You and your ex can agree to trade years.
In another example, you could link the claim to the enforcement of child support payments. If you have one child, you can claim them in odd years. Your ex can claim them during even-numbered years. If you are the noncustodial parent, you’ll require a signed form from the other parent to submit with your tax return.
Without it, the IRS will not allow you to claim the child-related exemption.
Child Tax Credit Rules Post-Divorce
The Child Tax Credit provides you $2,000 for each child under 17 years old. If you make more than $200,000 a year, the credit begins to phase out based on 2024 regulations. Then, the parent who claims the child as a dependent receives this credit.
If your custody arrangement changes from year to year, your right to claim this potentially refundable credit may change, too. This credit has the potential to reduce your entire tax bill dollar for dollar and may even provide you a refund.
Child and Dependent Care Credits
If you pay for daycare or after-school care so you can work, you could receive a tax credit. This credit is available to working or actively seeking work parents to help offset a portion of their expenses.
You have to track down and maintain receipts and records just even to claim it. Retain the original state.
Higher Education Tax Credits
Parents that support their children through college can receive education credits, including the American Opportunity Credit or Lifetime Learning Credit. You have to demonstrate that you’ve paid eligible tuition, and your income level has to be within the guidelines.
If you claim the child as a dependent, these credits can help you reduce your tax liability.
Property Division Tax Consequences
Undergoing a divorce in Pennsylvania? How you divide property matters. Both dividing property and dividing your property can have huge tax consequences. In places like Pittsburgh, couples must look at the value of what they own and know the rules for dividing things like homes, stocks, and savings.
Because various kinds of assets involve diverse tax implications, knowing these rules from the outset can help you avoid pitfalls down the road. FMV gives you a specific dollar amount that your possessions are valued at. More importantly, this information is key when you are trading items post-divorce or selling items post-divorce.
Asset Transfers: Generally Tax-Free
The IRS allows you to transfer most property between spouses as part of their divorce without immediately incurring tax liability. This rule applies to everything from bank accounts to stocks, or your marital home. If you plan to sell any of these assets in the future, hit hard.
You can likely face capital gains taxes depending on how much their value has appreciated. Through good planning, you can avoid these surprise bills. For example, if you get stocks in a split and sell them years later, you pay taxes on the “gain”—the difference between the cost basis and the sale price.
Understanding Cost Basis Transfers
Cost basis is what you initially paid for an asset. In a divorce, the cost basis travels with the asset. In short, if you make a long-term holding of a stock, you assume its initial cost basis for future tax liability.
Not knowing to split this information between you and your spouse can get tricky and result in expensive surprise taxes when you sell.
Selling the Marital Home
Selling your home after divorce can trigger taxes if you make more than $250,000 ($500,000 for joint filers) above what you paid. Exemptions from these taxes protect many from facing these burdensome taxes in the first place, but only if you follow specific guidelines.
Some decide to retain the house either for the sake of stability or in hopes of eventually selling into an improved market.
Dividing Investment Assets Carefully
Investment accounts conceal tax information that is critical at divorce. IRAs, stocks, and mutual funds tax requirements vary. To balance out your division, consider concealed costs or benefits.
Often, an equal division of property by asset type, rather than by value, creates equal footing.
Retirement Accounts in Divorce Taxation
During equitable distribution, retirement accounts take centerstage as they make up a large portion of retirement savings and tax impacts are important to consider. The law serves that any asset or saving during the course of the marriage belongs to the marriage. That means things such as 401(k)s, IRAs, and pensions.
As such, each spouse can receive a portion, and the amount a spouse will receive depends on factors such as the length of the marriage. The longer you’re together, the more the odds are that you’ll notice a clear-cut 50-50 split.
Use QDROs for Tax-Free Transfers
If a QDRO is necessary, when it comes to tax-free domain shifting of retirement funds, a Qualified Domestic Relations Order is the tool you want. Using a QDRO, a judge may require a retirement plan to disburse a portion to an ex-spouse.
This essentially enables the non-contributing spouse to get their share. Neither party will owe any taxes or early withdrawal penalties when the transfer happens. In order to receive a QDRO, you must obtain a judge’s approval and plan administrator acceptance.
Without one, moving retirement money can trigger big fees and tax bills—sometimes up to 10% or more, plus income tax.
Avoid Early Withdrawal Penalties
Withdrawing funds from retirement accounts prematurely during a divorce may result in additional expenses. If you take funds before age 59½ without a QDRO, you’ll face early withdrawal penalties on top of regular taxes.
A strategic approach, coupled with guidance from a tax expert, prevents things from getting messy. Putting in the time with knowledgeable, connected experts protects more of your hard-earned dollars and prevents costly blunders.
Consider Future Tax Liabilities
Splitting retirement funds now can have a tax impact later. For instance, cashing out a 401(k) or IRA could increase future tax liabilities.
If these assets, such as stocks, are sold later, capital gains taxes can accrue significantly. Being proactive, with guidance from someone with an understanding of the rules, ensures that you avoid being blindsided.
Choose Your Post-Divorce Filing Status
Post-divorce in Pennsylvania, choosing the appropriate post-divorce filing status sets the stage for your overall tax liability. To determine your tax filing status, the IRS considers your marital status as of the last day of the tax year. If your divorce decree is finalized by December 31, you qualify as “unmarried” for the entire year. However, if you have not yet finalized your divorce, you are still considered “married” in the IRS’s eyes, which can impact your finances significantly.
If you have finalized your divorce, you can opt to file as “Single” or “Head of Household.” While “Single” is straightforward, “Head of Household” provides more favorable tax rates and a larger standard deduction, which can be beneficial for those facing financial difficulties post-divorce. In order to qualify for this new status, you need to cover over 50% of the yearly expenses of your home.
Furthermore, your spouse must not have been living with you for the last six months, and your residence must be the primary dwelling of your child, stepchild, or foster child for more than half the year. You must have claimed the child as a dependent to take advantage of the dependent care enhancement tax credit.
For example, if you paid most bills and your child lived with you, you may qualify as “Head of Household” even if you and your spouse split up earlier in the year. Often, divorcing couples agree to alternate claiming at least one child as a dependent. You can negotiate that you will take turns, year by year, or base it on child support payments, which can lead to tax relief for both parties.
Switching up filing status is another often-overlooked alternative. Married couples who previously filed separate tax returns are given the option of converting to a joint return, provided that the established rules permit such action. If you adopted a child under 18, a tax credit of around $13,000 may apply, which helps with adoption costs, providing significant financial advantages during the divorce process.
Gather Essential Tax Documentation
Collecting all of your essential tax documentation is an important step when you get divorced in Pennsylvania. You aim to leave no stone unturned, so begin by gathering the last five years of tax returns—individual and business. If you’re self-employed or run a business, gather your year-end Profit and Loss Statements and Balance Sheets for that same stretch.
These documents collectively help to paint a complete picture of your income, any business losses, and overall money movement. It’s a good idea to maintain all corresponding schedules and attachments with each original return received as well. Documentation to track all financial moves, including alimony payments, asset transfers, and support payments is crucial.
Taking the time to do so now will save you from unexpected discoveries later on. Payment support is especially critical when you are called to show proof of funds paid or received. Here are the taxpayer implications, and why in Pennsylvania the child support system is set up to guarantee you don’t take a tax hit from these payments.
If you keep receipts and bank statements for each payment, you’ll have proof ready if anyone asks. These records allow you to find lucrative tax credits, like the Earned Income Tax Credit. This credit can provide significant help in easing financial burdens in the aftermath of a split.
Timing is important since sometimes tax rules can change based on when a document is signed or payment is received. In Pennsylvania, getting around these rules can get confusing and convoluted fast. An experienced divorce attorney who understands applicable state tax laws can help you navigate the process.
So, keeping good records of all your paperwork can help you avoid some of the headaches when the IRS comes knocking. You will be prepared to demonstrate precisely what you completed and on what date.
Avoid Common PA Divorce Tax Errors
Avoiding the common tax errors when going through a PA divorce can save you headaches and money. Most individuals overlook minor nuances that lead to major issues down the line. The IRS requires well-documented, truthful records, so documenting all payments and transfers protects you from the risk of audits.
The timing of your divorce will greatly influence your filing status for the full tax year. This change may get you a bigger refund or reduce the tax you owe. When you divide assets, tax laws such as TCJA and cost basis become key factors. If you sell the marital residence or stocks post-divorce and cannot establish their initial value, you could be in for a nasty surprise from the IRS.
Misclassifying Support Payments
Reporting alimony on your return when it should be child support (or vice versa) can subject you to IRS penalties. If your divorce settlement was signed prior to 12-31-2018, your alimony is considered taxable income in the Commonwealth of Pennsylvania.
Child support is not taxable income for either parent. If you miscategorize payments, the IRS can penalize you and increase your liability. Keeping careful records and having clear discussions with your ex can help avoid major issues.
Ignoring Asset Basis Rules
If you don’t know the starting value (“basis”) of assets you get in a divorce, you might get a surprise tax bill later. Let’s say you receive a house as part of your settlement and sell that house years later.
If you fail to report the proper basis, you may end up paying more tax than you realize. As you split up property, it can sometimes be worth it to check the value listed for each asset.
Incorrectly Claiming Dependents
Claiming your children on your tax return requires caution and attention. Custody regulations in Pennsylvania determine who gets to claim a child.
When both parents do end up filing for the same child, the IRS intervenes. Written agreements and clear settlements between individuals help prevent mistakes and serve to prevent IRS audits.
Overlooking QDRO Requirements
If retirement accounts are divided, this requires a Qualified Domestic Relations Order (QDRO). Failing to do so can expose you to unexpected taxation or substantial penalties.
To avoid these common pitfalls, legal assistance is critical to ensure compliance and protection of your retirement assets.
Failing State vs. Federal Coordination
Pennsylvania and the federal government don’t always agree on tax laws. When your state return and your federal return are not in alignment, you open yourself up to an audit or a delay.
Keeping informed on both will prevent costly mistakes.
Conclusion
Divorce upheaves your taxes in ways you can’t easily discern right away. Tax changes affect divorce in Pennsylvania. In Pennsylvania, rules can change very quickly, particularly with alimony and child credits. Sorting out the little things is all-important. Determining who claims the children, how you’ll divide the home and deal with former retirement accounts keeps major tax liabilities from surprising you. Getting it done properly, with the proper docs, means you get to hold on to more of your own money. These are the kinds of nitty-gritty I keep an eye out for, so you don’t miss out on any money. Don’t let these tax complications stress you out after a split – act now to protect yourself. Reach out to learn personalized next steps that make sense for you. Get proactive and position yourself to avoid bigger headaches in the future.
Frequently Asked Questions
What tax deductions and credits are affected by divorce in Pennsylvania?
Credits, such as the Child Tax Credit, and alimony deduction credits are affected by divorce proceedings. Each spouse’s eligibility for these depends on custody arrangements, child support agreements, and the new tax code versus Pennsylvania state tax laws.
Is alimony taxable in Pennsylvania after divorce?
There is a significant caveat for divorcing couples in Pittsburgh regarding divorce proceedings finalized after 2018. As of 2017, under federal law, alimony payments are no longer deductible by the payer spouse or taxable to the receiving spouse, a rule that Pennsylvania adopted.
Who claims the child tax credit after a Pennsylvania divorce?
Typically, the custodial parent is the one who claims the Child Tax Credit, while many couples may agree in writing for the non-custodial parent to claim it, ensuring legal guidance in their divorce proceeding.
Are there tax consequences when dividing property in a Pennsylvania divorce?
The good news is that property transfers from one spouse to another during the Pittsburgh divorce process are usually tax-free. However, if they eventually sell the marital property, there could be capital gains tax liability involved. It is essential to keep track of the value of any property transferred at the time of the divorce proceeding.
How are retirement accounts taxed during a Pennsylvania divorce?
Moving retirement accounts through a Qualified Domestic Relations Order (QDRO) allows divorcing couples to avoid instant taxes or penalties, ensuring that distributions after the transfer are taxed as income.
What is the best filing status after a Pennsylvania divorce?
If you are a divorcing couple by December 31, you can file as Single or Head of Household. Head of Household offers beneficial tax breaks, including the dependent care enhancement tax credit, provided you meet the IRS guidelines, such as having a qualifying dependent.
What common tax mistakes should divorcing couples in Pennsylvania avoid?
Examples of common mistakes include allowing both parents to claim the same child, not realizing that alimony is no longer tax-deductible under the new tax code, or incorrectly transferring marital property like retirement accounts. To prevent IRS penalties, always consult an experienced divorce lawyer for legal guidance before making these changes.