ADOPTION TAX CREDIT

There has been a lot of confusion regarding whether the federal Adoption Tax Credit would extend from 2011 and into 2012. So let's set the record straight with some good news. On December 17, 2010, President Obama signed into law the extension of the Adoption Tax Credit not only through 2011, but until December 31, 2012. This is wonderful news for the adoption community. It will later be determined by Congress if the federal adoption tax credit will continue into 2013 and beyond.

How much is the adoption tax credit?

The 2011 federal tax credit is $13,370. Adoptive parents may claim the tax credit if their modified adjusted gross income is not more than $185,210. For those with incomes in excess of this amount, the credit can still be claimed up to modified adjusted gross incomes of $225,210, but the credit proportionally decreases as the maximum income level is approached.

The 2012 federal tax credit is $12,650. The maximum modified adjusted gross income to claim the full credit is $189,710. Beyond tat income, the credit may be taken in proportionally smaller amounts up to a modified adjusted gross income of $229,710.

How is a credit different than a deduction?

It is important to recognize this is an adoption tax credit, not a mere deduction. A tax credit is far better than a deduction. For example, a common taxpayer deduction is interest paid on a home mortgage. The deduction is subtracted from the taxpayer’s taxable income, then the tax owed is determined. A credit, however, is a dollar for dollar elimination of tax owed.

The credit is "refundable" in 2011 but not in 2012.

Making the 2011 adoption tax credit even more attractive is that for the first time, the tax credit is refundable. Previously, the tax credit offered little benefit to lower income adoptive parents. because if they had no, or little, tax liability, there was no tax owed to offset with the credit. For 2011, however, that changed. A refundable credit means that the credit will be paid in the form of an actual refund from the Internal Revenue Service even if there are no taxes owed. Notably, the new regulations only make the tax credit refundable for 2010 and 2011, not 2012. In 2012 it is a standard tax credit (not refundable) as it was for 2009 and prior years. (But even a "standard" tax credit is still outstanding.)

A critically helpful factor to be aware of, benefiting everyone (particularly those adopting in 2012 when the tax credit is not refundable), is that there is a five year carryover period. This means that if the adoptive parents are eligible for the full tax credit due to having qualified adoption expenses up to the tax credit amount, but their tax liability is less than their adoption expenses, leaving "left-over" credit, the "left-over" credit carries over each year, to a maximum of five years, until the credit can be used to offset tax liability.

What adoption expenses count towards the tax credit?

The federal adoption credit can be claimed for any lawful expenses in an adoption (agency fees, attorney fees, birth mother’s counseling and legally permitted assistance with living and medical costs). The tax credit applies to both domestic (independent and agency) and international adoption. It does not apply to step-parent or adult adoptions.

When do you take the credit? It differs in domestic and international adoption. In domestic adoption there is some flexibility:

For adoption expenses paid before the adoption is final, the adoptive parents take the tax credit in the year after their adoption expenses were paid.
For adoption expenses paid in the same year the adoption is finalized, the adoptive parents take the tax credit in that same year.
In the unlikely event there are adoption expenses in the year after the adoption is final, the adoptive parents take the tax credit in the year in which the expenses were paid.

In international adoption, the expenses are normally accumulated until after the adoption is finalized, then taken at once in the year of finalization.

Let's look at some common scenarios with the 2011 refundable tax credit. If adoptive parents Steve and Mary incur adoption expenses of $17,000, and they have a federal tax liability of $5,000, the credit would eliminate the $5,000 tax liability, and result in an IRS check to Steve and Mary for the balance of the $13,170 tax credit, which would be $8,170.

If adoptive parents Jacob and Claire only incurred $10,000 in adoption costs, their credit would be $10,000, not $13,170, since the tax credit only rises to $13,170 if actual expenses were incurred to that sum. An exception is if the child being adopted is deemed "special needs" by applicable law, in which case the adopting parents are entitled to the full credit (if income eligible) even if their actual expenses did not reach $13,170. Thus if Andrew and Dorothy adopted a designated special needs child in a county agency adoption and their cost was only $500, they are still entitled to the full $13,170 credit.

Download Adoption Tax Credit form 8839.

The actual IRS form used to claim the Adoption Tax Credit is Form 8839 (Qualified Adoption Expenses). This form can be obtained from the IRS by calling them at 1-800-829-3767 or download one at http://www.irs.gov/pub/irs-pdf/f8839.pdf.

For those wishing to read the exact language of the Adoption Tax Credit’s extension, it can be found in the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010, title I, section 101(a). Please be aware this article should not be relied upon as legal or tax advise. Tax laws are complicated. To confirm how the Adoption Tax Credit applies to you and verify our brief summary is correct and applicable to you, consult a tax professional.

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