An adoption tax credit is the credit or tax deduction that adoptive parents receive which encourages 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 no 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 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
- 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:
- The child or the youth can no longer be returned to his or her biological parents, for any reason.
- 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 paperwork 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 paperwork, 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 over the liability can be carried to the next five years.
Qualified adoption expenses
Expenses for qualified adoption 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 in 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 was 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:
- The child is a US citizen, or a resident of the US during the adoption process started.
- A state has already determined that the child should not and cannot be returned to his or her biological parents.
- A state has already determined that the child should be put into someone else’s care.
- 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 to claim the 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
Various states 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