Good parenting is hard work. The rewards far exceed anything the tax code has to offer, but it is nice to take advantage of the tax benefits when the time comes, whether or not your children are adopted or biological. The tax code does not discriminate in this regard, and parents of adopted children can even take advantage of something called the “Adoption Credit” to counteract the often expensive journey to adopt a child.
Adoption Tax Credit
The adoption credit is a dollar for dollar reduction of an individual’s taxes owed, with a maximum amount of $13,460 per child. The expenses that qualify for the credit, as with all credits, have to meet certain criteria. These include reasonable and necessary adoption fees, court costs, attorney fees, travelling expenses, or other expenses directly related to and for the principal purpose of adopting a child. Along with the dollar limitation mentioned above, there exists an income phase-out scale for taking this credit. The scale begins when an individual’s income meets or exceeds $201,920 and will be not be available to taxpayers who have income greater than $241,920.
There are a few timing factors to keep in mind when using the adoption credit, especially if the adoption takes place over multiple years. The first factor to note, however: Is the adoption considered domestic or foreign? The difference between a domestic and foreign adoption is that the foreign adoption has to be finalized for the taxpayer to claim the credit. If the adoption, therefore, is domestic, you can claim expenses in the year they are paid. If the adoption is foreign, you have to wait until the adoption is finalized to make any claim. The domestic adoption expenses can be claimed in the year they were paid regardless of if the adoption was even finalized.
For example, you decided you wanted to adopt a child in November 2015 and had $3,000 in expenses in 2015. At the end of 2015, the adoption was not yet finalized and in 2016 you spent another $5,000. If this is a domestic adoption you could claim a $3,000 credit in 2015 and a $5,000 credit in 2016. If, however, this is a foreign adoption you would have to wait until the adoption finalized in 2016 to claim an $8,000 credit.
For domestic adoptions that are not finalized there is an additional rule. If you do not finalize an adoption and you try to adopt again, the expenses that you claimed as a credit will count toward your next adoption. If the second adoption attempt is also unsuccessful the same process applies until you have a successful adoption. For example, you try to adopt in 2014 and have $3,000 of expenses that you claim with the tax
credit. The adoption does not finalize and you decide to try to adopt again in 2016. You will only be able to claim a maximum of $10,460 ($13,460 - $3,000) on your 2016 taxes.
Employer Provided Adoption Assistance
Some employers will provide their employees with financial assistance if they are trying to adopt a child. Usually if an employer provides any form of compensation, it is considered income and can be taxable. The IRS did not want taxpayers to have to include a portion of this assistance in their income so there are rules on how to exclude it. Similar to the Adoption Tax Credit, the excludable portion of any employer-provided adoption assistance has an income and dollar limitation. The phase-out amount is exactly the same as the tax credit, so once a taxpayer’s income is over $201,920 the phase-out begins. Once a taxpayer’s income is over
$241,920 they will no longer be able to claim any exclusion from employer-provided assistance. If your employer provides assistance you can use the income exclusion and still claim a credit, but there are rules regarding how to do this correctly. A taxpayer must claim an exclusion amount before they can claim any credit amount.
For example, a taxpayer has $10,000 of qualified adoption expenses. Their employer
reimburses them for $2,000. This tax payer would exclude the full $2,000 from their income and then take an $8,000 tax credit for the remaining expenses.
Example 2, a taxpayer has $15,000 of qualified adoption expenses. Their employer
reimburses them for $4,000. This tax payer would exclude the full $4,000 from their income and then take an $11,000 tax credit for the remaining expenses.
Example 3, a taxpayer has $30,000 of qualified adoption expenses. Their employer
reimburses them for $13,460. This taxpayer would exclude the full $13,460 from their income and then take a $13,460 tax credit. The remaining expenses will not be eligible for the exclusion or the tax credit.
This ordering is to prevent the taxpayer from claiming the same expenses for both the credit and the exclusion. However, the taxpayer can use both the exclusion and the credit to receive tax benefits for their qualified adoption expenses.
There are multiple ways for parents of adopted children to receive the tax benefits just like biological parents. Taxpayers may want to see if their employers offer assistance for parents trying to adopt so that they can secure extra financial help to take away some of the financial burden that comes with adopting. AND as always, don’t forget to hold on to any and all documentation! It is necessary for claiming any tax benefit in case of an IRS audit.