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Understanding Adoption Costs and the Deduction Taxpayers Can Claim

An adoption tax credit is the credit or tax deduction that adoptive parents receive which encourage adoption. It is stated in Section 36C of the Internal Revenue Code of the United States, and it provides credit for “qualified adoption expenses.” These are incurred or paid by taxpayers.

According to IRS, adoption costs and tax credit include qualified adoption expenses to pay for the adoption of an eligible child which also serves as an exclusion for the employer to provide adoption assistance.

Tax Year to Claim Adoption Costs

Domestic adoption expenses can be claimed for the tax credit of the given income tax year as long as both have been paid. Domestic and foreign adoption costs can be claimed in the given tax year when the adoption process is finalized. Domestic adoption expenses are also accepted even during the adoption process. The accumulated adoption expenses for every child are credited on the previous year as long as it has been evaluated and determined fit and suitable for the maximum tax credit.

Qualified Adoption Expenses

As stated in the US tax law regarding adoption costs, the qualified expenses cover fees such as the adoption costs, attorney fees, court costs, traveling expenses (which also includes the cost of meals and lodging while on the road) and other miscellaneous expenses that are related to the taxpayer legally adopting a child that is deemed eligible. The adoption tax credit per child is doubled when two children are adopted in the same year. It is very important to note that this is credit and not deduction. This means there is a higher deduction considering it is the latter. To elaborate more,  the tax credit is a dollar for dollar reduction which means that the deduction from the credit is the total amount per dollar, which makes it a bigger deduction that what would have been subtracted if it were a mere deduction.

If the adopted child is one with special needs, the parents can claim full credit even without documenting the expenses. There are specific factors that determine the qualifications and the benefits of the child with the special needs and they vary from state to state. A qualifying child that has special needs because of a condition or factor may involve any of these:

  • Racial background or ethnicity
  • Age
  • Emotional, physical or medical disabilities
  • Risk of emotional, mental and physical disability due to birth family history
  • A condition that makes it difficult for the child to find a family that can adopt him or her

There are broader and more elaborate definitions of “special needs, ” and these can be used to determine if the child is qualified for the financial assistance from the Federal Government regarding the adoption of youth and children within the US foster care system.  There’s no single definition of what special needs are, but according to the Social Security Act, under Title IV-E, the child or the youth that has special needs must meet both requirements to be qualified for Federal Adoption Assistance:

  1. The child or the youth can no longer be returned to his or her biological parents, for any reason.
  2. It is the best interest of the child or the youth to be placed in a caring environment.

The adoptive parents must document the child with special needs every paper work that they get their hands onto. The documentation includes assistance for the adoption, the subsidy agreement concerning the adoption, and the letter from the state or county that the child welfare agency is situated.

Taxpayers should document all the financial records including the written adoption paperwork, home study paper work, and legal agreements. Most audits concerning adoption tax credit can be completed by correspondence through an audit. The taxpayer and the accountant can communicate with the IRS via fax or mail. Tax audits also occur every three years so records that are concerning adoption expenses should be kept and retained.

Internal adoptions also require more paperwork as well as registration when the child from abroad has been adopted and then starts living in the US. Social Security Numbers and Social Security Cards, as well as passports and birth certificates along with US readoption,  are also required.  Additional documents that are needed for a child to permanently reside in the US are of great importance, and taxpayers must keep this. Readoption is also a means of documenting the child-parent relationship as stated in US law.

Adoption Credit and Adoption Assistance Programs

Tax benefits for adoption can also include the tax credit for a qualified adoption cost that will be paid by the qualified child, as well as the exclusion from the income of the employer that provides the adoption assistance. The adoption costs are non-refundable which means that it is limited to the taxpayer’s liability for that income tax year. The credit in excess of the liability can be carried to the next five years.

Qualified adoption expenses

Expenses for qualified adoption an also include the home study if the child is physically or mentally incapable of attending a traditional school.

Qualified adoption expenses include the costs that are paid by the registered domestic partner of the taxpayer who lives in the same state for same-sex second parent or co-parents. Adoption of same-sex couples has already been defined so that the child they adopt is covered by adoption costs expenses and can, therefore, qualify for the credit.

Income and Dollar Limitations

There are limitations for credit and exclusion per child. The income limit on the adoption cost depends on the MAGI or the modified adjusted gross income. If that amount falls between the specific limit, then the credit of the taxpayer is excluded to the phaseout, whether it be eliminated or reduced.

The dollar limit for the specific income tax year must be reduced based on the amount of the qualified adoption expenses. These are then claimed in the previous years for the adoption effort. When computing for the dollar limitation, the adoption costs that are paid and claimed about the unsuccessful adoption effort should be combined with the qualified adoption costs that are paid in subsequent attempts, whether the adoption was successful or not.

The dollar limitation also applies to both the exclusion as well as the credit that the taxpayer can claim both of these for the adoption costs. However, if the taxpayer can claim the exclusion that is allowed before claiming any credit, then the expenses used for the exclusion that will be reduced from the amount of the adoption costs will be available for the credit. This results to the taxpayer not being able to claim both the credit as well as the exclusion from the adoption tax credit.

When can the Adoption Costs Credit be claimed?

The tax year for which the taxpayer can claim the credit depends on these:

  • Whenever all expenses are paid.
  • Whether the adoption is domestic or foreign.
  • Once the adoption has finalized.

The adoption costs that are allowed for domestic or foreign adoption depends on the timing rules that claim the credit, whether or not these are qualified. It depends entirely on the kind of adoption.

  • Domestic adoption is when the child is a US citizen (whether he is a natural citizen or a resident of the US during the adoption process) is eligible for the process, and all the expenses are paid even before the income tax year ends, and the papers have been finalized. The credit for the income tax year follows the coming years for the payment.
  • Foreign adoption is the adoption of a child that is qualified who is not yet a citizen, nor the resident of the United States. Qualified adoption costs that are paid before and even during the income tax year are allowed and considered as credit for the income tax year when the adoption is finalized.

Once the adoption is finalized and subject to the limitation, the adoption costs that are qualified are paid during and sometimes after the year as credit for the payment, whether the adoption is domestic or foreign.

Adoption of US children who have special needs

If the taxpayer adopts a child that is declared to have special needs by the state, then the taxpayer is eligible for the maximum amount of credit.  The maximum amount is then reduced by qualified adoption expenses for the qualified child in the previous years. The limitation regarding MAGI also applies.

If the taxpayer adopts a child whom the state has determined with special needs, then the employer of the taxpayer has written and qualified adoption assistance. This also makes the taxpayer eligible for the exclusion, even if the taxpayer and the employer have no records of adoption costs.

A child is considered to have special needs, as defined by the adoption costs, if:

  1. The child is a US citizen, or a resident of US during the adoption process started.
  2. A state has already determined that the child should not and cannot be returned to his or her biological parents.
  3. A state has already determined that the child should be put into someone else’s care.
  4. A common mistake is confusing “children with special needs” along with the whole point of having an adoption credit. Foreign children are not considered eligible to benefit from what is regarded as the special needs, simply for the purposes of claiming adoption credit. Even American children who are disabled cannot have special needs so that they can get deductions for the adoption costs. Special needs pertain to the children who are mentally, physically and emotionally disabled.

State Adoption Tax Credits

There are various states that offer additional tax credits regarding adoption to benefit their residents. If taxpayers live in such a state, then they are offered with a state-level adoption tax deduction and credit. Taxpayers can add their tax experts if they are eligible for these.

Adoption Disruption Still Applies for Tax Credit Benefits

Families who have gone through situations wherein an adoption process has been disrupted can still benefit from the tax credit. Families that qualify for these can also deduct the qualifying adoption expenses on the disrupted adoption. Nonetheless, these families have to wait for a whole year to go by even before they can file for the credit. The maximum credit also applies no matter how many adoptions, whether these pushed through or were disrupted, that the family has experienced for that income tax year.

Dependency Tax Exemption

Adoptive parents can also take the similar dependency exemption that is stated on their income taxes that can greatly benefit the adopted children, including children who are placed under their care, even if the adoption is not yet finalized. The exemption also deducts the taxable income. Families must then provide half of the child’s support to make the exemption costs.

Adoption Tax Credit Before Finalized

Each year, adoptive families inquire whether they can still file their taxes and not have their child’s SSN. This is not possible because the SSN is received once the child has been successfully adopted. The adoption attorney of the taxpayer should then apply for the child’s SSN along with the birth certificate that has been amended. This is very crucial for the court hearing especially when it is being finalized. Taxpayers who do not have these just yet must turn to their accountant, tax representatives, or tax experts so that they can apply for a TIN that is temporary which the child needs. Taxpayers can also file for the taxes using that number.

Filing Tax Returns with Adoption Tax Credit

Due to documentation and the increase in requirements, the Affordable Care Act is introduced, and it helps taxpayers claim the necessary Adoption Tax Credit that can be filed under the income tax year and with the help of a professional accountant.

adoption tax credit

Adoption Tax Credit

While adopting a child is a noble and loving gesture, it also comes at a hefty price. Many parents who either have or are looking to adopt a child will spend up to $30,000 before all paperwork is finalized. This number varies greatly depending on where the child is being adopted from and where the parents live of course. For example, A Pennsylvania, U.S. mother adopting a child from a bordering state will not pay nearly as much as if she was adopting a child from India or Africa.

Why is there a Tax Credit for Adoption?

The adoption tax credit was established in the early 2000’s for several reasons. Children were being forced into the adoption system more regularly than in previous years. In order to both increase public awareness on the adoption system and encourage parents to adopt, a tax credit was made. This tax credit is explained in detail in the following paragraph, but it is essentially a portion of your expenses made during the adoption process.

Even though adoption a child is expensive, you will receive a portion of your funds back and you will help take a child out of the system and give them a happier, healthier life. Special needs children are the main targets of the tax credit because, unfortunately, they are the least likely to be adopted.  Taking a chance and adopting a child is great for parents emotionally and now financially as well.

The Adoption Tax Credit Overview

Relief is available for parents looking to adopt a child. The adoption tax credit offers parents of adopted children a money back wager each year, which will save them money and reduce their tax expenses. According to the IRS Form 8839 – Qualified Adoption Expense – parents can receive up to $13, 190 per year per each adopted child.

However, these adopted children need to pass a single requirement in order to be considered eligible for a tax credit.

  • Child must be under the age of 18 and/or mentally/physically unable to take care of themselves.

It is important to remember that this tax credit can only be granted towards fees applying directly to the adoption process. This means that fees relating to the court system, hiring an attorney, traveling expenses, home inspections, etc. can be reimbursed. Fees relating to the child such as food, healthcare, school, etc. cannot be reimbursed under the adoption tax credit.

Adoption Tax Credit and Special Needs Adoption

 If the parent(s) is adopting a child who qualifies as special needs (see requirements below), they are automatically allowed to receive the max amount of reimbursement. This applies regardless of the amount of money spent during the adoption.

Special Needs Requirements

  • It is unlikely that the child would have been adopted if additional help weren’t available.
  • The child can’t or shouldn’t be returned to the biological parent’s home.
  • The child is a citizen or resident of the United States (if international, this rule bends depending on location of adoption)

 Applying for the Adoption Tax Credit

 Whereas most tax credit forms can be submitted online, the adoption tax credit is not. This tax credit is applied for completely on paper. There are several steps a parent needs to complete and several forms that need to be filled out in order to apply and receive their adoption tax credit.

  •  – IRS Form 8839 must be filled out and sent to the IRS prior to any other steps.
  • A paper copy of the adoption certificate signed the specified judge is needed.
  • If your child is special needs, a certificate signed by the state that specifically states the child is special needs and that he/she meets all of the qualifications, must be submitted to the IRS.

There are several other paper documents that need to be signed, including a rights of the child form, a few adoption agency forms stating your responsibilities, house inspection forms, etc.

Expect a Delay

Due to the Adoption Tax Credit application being an all paper process, the submission and acceptance of the tax credit can take a while to go through. Expect at least 4 weeks, likely more, before you hear back about confirmation from the IRS.

Subnote

 If a parent tries to adopt a child and for some reason is not able to, he/she can still apply for the Adoption Tax Credit in order to get a reimbursement on their expenses up to the point of termination of the adoption. There are no specific qualifications that need to be met in this case, other than that the adoption cannot be canceled due to a failed home inspection or declaration of unfit parents.

Conclusion

 Adopting a child is a blessing for both the parents and the child. With expenses being high and the adoption process being exhausting, the government has created a way to ease your stress through the Adoption Tax Credit. For more information, visit the IRS website or your local adoption agency today.