ADOPTION TAX CREDIT
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Great news for adoptive parents! The federal adoption tax credit has been renewed for 2015.
How much is the adoption tax credit?
The 2017 federal adoption tax credit is $13,570. Adoptive parents may claim the tax credit if their modified adjusted gross income is not more than $203,540. For those with incomes in excess of this amount, the credit can still be claimed up to modified adjusted gross incomes of $243,540, but the credit proportionally decreases as the maximum income level is approached. (The amount of the tax credit, and the permitted income to qualify for it, varies slightly every year.) There are special rules and benefits to those adopting a special-needs child, as provided below.
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 was once "refundable" but is now a "standard" tax credit .
In 2011 the adoption tax credit was refundable. That meant that the credit would be paid to the adoptive parents in the form of an actual refund from the Internal Revenue Service even if there were no taxes owed. Starting in 2012, the credit is a standard tax credit (not refundable). But even a "standard" tax credit is still outstanding. What that simply means is that you must have paid federal taxes (or taxes are owed) for the tax credit to offset those taxes. For example, if you paid (or owe) $15,000 in federal taxes for the year, you could claim the $13,570 tax credit and be left owing only $1,430 in taxes. If your income for the year was modest (or you had a lot of deductions lowering your tax liability), and you only paid (or owed) $3,000 in federal taxes for the year, this means you could claim $3,000 under the tax credit and have that full amount refunded.
A critically helpful factor to be aware of, benefiting everyone, is that there is a five year carryover period. This means that if the adoptive parents are eligible for the 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 after the year of the initial tax filing, 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. So if the expense was paid in 2016, it would be claimed on the 2017 tax return, which would actually be filed in 2018.
- For adoption expenses paid in the same year the adoption is finalized, the adoptive parents take the tax credit in that same year. So if paid in 2017, it is taken on the 2017 tax return, filed in 2018.
- 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 2017 tax credit. If adoptive parents Steve and Mary incur adoption expenses of $17,000, they can only claim to the tax credit maximum of $13,570, even if their qualified adoption expenses were higher. And if their federal tax liability when taking the credit was $5,000, the credit would eliminate the $5,000 tax liability, and result in an IRS refund to Steve and Mary for the $5,000. The credit would not be for more than the $5,000 that year because the tax credit for a traditional (non-special-needs) cannot exceed the actual tax liability. But the balance of the unused credit ($13,570 - $5,000 = $8,570) would carry over each year and be a credit for tax owed in those years, up to five years, until the full credit of $13,570 is taken.
Again with the 2017 tax credit, if adoptive parents Jacob and Claire only incurred $10,000 in adoption costs, their credit would be $10,000, not $13,570, since the tax credit only rises to $13,570 if actual expenses were incurred to that sum.
Angelo and Madeline adopt a child deemed "special needs" by applicable law. They do not need to show they incurred any adoption expenses at all. Even if their adoption was completely free by their county adoption agency, they are entitled to the full tax credit (so $13,570 if the 2017 credit)., in which case the adopting parents are entitled to the full credit (if income eligible) even if their actual expenses did not reach $13,570. 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 $13,570 credit. They must still have tax liability to earn the credit, however, as the credit is still non-refundable, even for special-needs adoptions.
How is a child determined to be special-needs?
Just because a child has a medical issue, is a sibling group or of an ethnic minority, or is an older child, may not be sufficient to be considered "special-needs" for purposes of the federal adoption tax credit. The county or state child welfare agency involved must have designated the child as special-needs. The vast majority of adoptions of children adopted from foster care, however, are usually determined to qualify. Adoptions arranged via independent adoption would very rarely be found to be special-needs. Children adopted via international adoption cannot be considered special-needs for purposes of the tax credit, regardless of the existence of any special-needs.
Can I take the tax credit more than once?
Yes. The credit is per child. So if you adopt two children, related or not, in 2017, the credit would be $13,570 X 2 = $27,140. Or, if you adopted a child in 2014 and again in 2017, you take the credit for each child individually based upon the tax credit for that year. Most tax experts state you can take the credit for a failed adoption (meaning there was an actual planned placement) as well.
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 the form for 2016 at http://www.irs.gov/pub/irs-pdf/f8839.pdf. As of the time this article was written, the IRS had not uploaded the 2017 form, but when it does, this link will likely automatically be converted to that for the 2017 form.
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.