Adopting is a very fulfilling and is a great way to grow your family and can be a wonderful experience but a costly one and the IRS understands this. This article will provide you with a brief, not all-inclusive, explanation on the adoption tax credit, limitations and some examples of the qualified expenses.
Adoption tax benefits consist of a tax credit for approved adoption costs incurred when adopting an eligible child, as well as an exclusion from taxable income for adoption assistance provided by an employer.
What are eligible qualified expenses?
The credit covers a wide range of adoption-related costs, including but not limited to:
- Adoption agency fees
- Attorney fees for legal services
- Court costs
- Travel expenses for both adoptive parents and the child
- Medical expenses for the child prior to adoption if it is applicable
It’s important to note that the Adoption Tax Credit is available for both domestic adoptions and international adoptions, although the costs for international adoptions can be higher due to travel and international legal requirements.
Amount of the Credit
The amount of the Adoption Tax Credit can change annually, and it is subject to inflation adjustments. For example, for tax year 2023, the maximum credit available per child was $15,950. This amount may increase slightly in subsequent years based on inflation rates. For the 2024 tax season, the maximum credit is $16,810 per child.
For families adopting children with special needs, the credit may be applied even if the adoption expenses are lower than the maximum allowable amount. The tax credit for special needs adoption is typically equal to the maximum amount, regardless of the actual adoption expenses incurred.
Income Limitations, Timing & More
The Adoption Tax Credit is subject to income limits, meaning that high-income families may find their credit reduced or phased out altogether. The eligibility for claiming the full credit begins to phase out for families with a modified adjusted gross income (MAGI) above a certain threshold, which changes annually. For 2023, the phase-out range started at $239,230, and the credit is completely phased out for families with a MAGI above $279,230.
The Adoption Tax Credit is nonrefundable, which means it can only reduce your tax liability to zero. If your tax liability is less than the amount of the credit, you will not receive the difference as a refund. However, any unused portion of the credit can be carried forward for up to five years, allowing families to benefit from the credit over multiple years if they cannot fully use it in the year of adoption.
One of the most beneficial aspects of the Adoption Tax Credit is that it offers a standardized credit amount for children adopted from the foster care system who are considered to have special needs. The term “special needs” doesn’t necessarily refer to a child’s medical or psychological condition but is instead a designation that applies to children in foster care who are typically harder to place due to age, race, or other factors. For these children, the credit is available without the need to document specific adoption expenses.
The timing rules for this tax credit can be confusing and depend on a few factors. These factors include:
- When the expenses are paid
- Whether it is a domestic or international adoption
- When the adoption was finalized
Generally, the timing rules for qualified adoption expenses differ depending on the type of adoption. Given the complexity of tax credits and the nuances in adoption law, many families find it helpful to consult a tax professional or financial advisor to ensure they’re claiming the credit correctly.
How to Claim the Credit
Claiming the Adoption Tax Credit requires filling out IRS Form 8839, Qualified Adoption Expenses, along with your tax return. This form helps the IRS determine the total amount of qualifying adoption expenses and the amount of the credit you are eligible to claim. If you are adopting a child with special needs, you will need to ensure that the child’s status is documented, either through a state adoption agency or the court system. Below is a short list of steps in the process:
- Gather documentation- Compile receipts and records of all adoption-related expenses
- Complete IRS Form 8839- Use the form to report the expenses and calculate your credit
- Include the above Form with your Tax Return- Submit with your regular Form 1040.
Key Considerations
There are three key considerations to keep in mind with the adoption tax credit. First is with multiple adoptions. Families who adopt more than one child in a single year may be eligible for a larger credit, as the tax credit applies per child. Each adoption has its own set of qualifying expenses. The second key consideration is the carryforward option available. If your credit exceeds your tax liability, you can carry the remaining balance forward for up to five years. This is especially helpful for families with smaller tax liabilities in the year of adoption. The third consideration is to consider potential state adoption tax credits. In addition to the federal credit, some states offer their own adoption tax credits. These vary widely by state and may cover some or all adoption-related costs, offering additional financial assistance to families. Please seek advice on your specific state and their credit.
The Adoption Tax Credit is a valuable tool for families who are navigating the often-expensive process of adoption. It provides significant financial relief, especially for those adopting children with special needs, and offers families an opportunity to reduce the cost of expanding their family. While the process of claiming the credit requires careful documentation and adherence to IRS guidelines, the financial benefits it offers make it a crucial resource for prospective adoptive parents. Families interested in adopting should consider consulting with a tax professional to ensure they are taking full advantage of this important credit.
Written by Allura Taylor, Staff Accountant