How Does the Tax Credit Work?
Expanding your family is expensive, no matter how you go about it. Because insurance usually covers medical bills, we tend to overlook the fact that a hospital birth can cost up to $25,000. Adopting a child, on the other hand, can cost at least this much, and thousands more — without insurance benefits to claim.
In an effort to reduce the cost of adoption, the federal adoption tax credit was introduced in 1996. It allowed families to deduct up to $5,000 ($6,000 for a special-needs adoption) in qualified adoption expenses from the total amount of taxes they owed. Still, under this law, families with low incomes and little or no tax liability could not take full advantage of the credit. In 2001, the credit was increased to $10,000 per adoption attempt, and the maximum was adjusted for inflation in subsequent years. The 2001 bill also provided a ‘flat credit’ to families completing special-needs adoptions, which meant that they were eligible for the full credit, regardless of their expenditures.
Adoption Tax Relief Today
In January 2013, President Obama signed a bill to avert the “fiscal cliff,” which made the adoption tax credit permanent. For tax year 2015, the maximum credit is $13,400 per attempt. Families with a modified adjusted gross income (MAGI) from $201,010 to $241,010 may claim only a partial credit. Families with a MAGI above $241,010 may not claim the credit.
Starting in 2012, the adoption tax credit once again became nonrefundable, meaning that it can only be claimed by families with a tax liability. Generally, this excludes lower-income families. In addition, income restrictions mean that families in higher tax brackets have to claim a reduced credit, or will not be able to claim a credit. Parents adopting special needs children may be able to claim the full amount regardless of expenses, although the IRS’s definition of “special needs” is unusually narrow. It excludes international adoptions, and many children with disabilities. However, most foster care adoptions qualify.
If parents receive adoption assistance benefits from their employers, they may exclude it from their taxable income. However, they will not be able to claim both an exclusion and a tax credit for the same expenses. For example, if a family spent $15,000 in qualified expenses, and one parent’s employer provides adoption assistance benefits, the family could claim a tax credit of $13,400, and exclude $1,600 from their taxable income.
What Expenses Qualify?
‘Qualified adoption expenses’ are reasonable and necessary expenses directly related to adoption. These include agency/attorney fees, court costs, and travel. Costs that were reimbursed by an employer or were funded under a government program are not eligible. Because the credit may be taken for each adoption attempt, costs associated with a failed domestic adoption qualify.
Parents who adopt a special-needs child can generally claim the credit, even for expenses that fall outside the definition of ‘qualified adoption expenses.’
Although it does not eliminate the need for an initial outlay of funds, the tax credit does relieve the financial burden of adoption.
This information is intended as a general overview and should not be relied upon as a substitute for the advice of a qualified tax professional.