The Federal Adoption Tax Credit; General and Specific Issues

The following is a general overview of the Federal Adoption Tax Credit and attempts to address certain questions that adoptive parents may have.  The ultimate issue with the Tax Credit now is that it is scheduled to sunset at the end of 2012, and most of its significant portions will not apply in 2013.

WHAT IS A TAX CREDIT?  Generally, a tax credit is used to reduce the amount an individual owes in taxes to the federal government.  For example, let’s say that one owes the government $100 in taxes after calculating income, but there is a $10 tax credit available for which one qualifies.  This reduces final tax liability to $90. At the most basic level, this is how the Adoption Tax Credit operates in 2012.  The IRS website provides examples of the applicability of the credit.

WHAT IS THE PURPOSE OF THE TAX CREDIT? It is intended to reimburse individuals and families for certain qualified expenses incurred during the adoption process.  It is also intended as a mechanism to encourage adoption as a method of family growth.

HOW DOES THE TAX CREDIT WORK? This is a one-time credit for each adopted child.  If a child was adopted in 2009, one could claim the credit in 2009.  If the credit was claimed in 2009, it cannot be claimed again the following taxable year.  If one adopted two children in 2009, one could claim the credit twice for that year.  In the years 2010-11, the credit is refundable, meaning that one would actually get a check in the mail if the adoption was finalized in those years, offset by any income tax owed.  However, in 2012, the credit is non-refundable, meaning the credit reduces the amount owed to the government by the amount shown in the table below, but no refund check will be issued.  Finally, this reduction can extend for up to five years, or until it has been exhausted.

WHICH EXPENSES QUALIFY?  The tax credit will not take into account every expense incurred during the adoption process. The IRS allows the following expenses to be covered by the credit:  (1) adoption fees, (2) attorneys fees, (3) court costs, (4) travel expenses (including meals and lodging) and (5) re-adoption expenses related to the adoption of a foreign child.  Expenses that the government expressly excludes from the credit: (1) any expenses that were already reimbursed by employers and state or local governments, (2) expenses that violate state or federal law, (3) expenses resulting from a surrogate parenting arrangement, and (4) expenses incurred during the adoption of the spouse’s child.

TAX CREDIT EIGIBILITY?  If one earns too much in a given year, one will not be able to qualify for the credit. For example, in 2011, those whose modified adjusted gross income exceeds $225,210 are ineligible to take advantage of the tax credit. Also, in 2011, if a family earned more than $185,210, but less than $225,210, they would qualify for a partial credit. For 2010, that cap is $222,250 with a partial credit offered if income is over $182,520. Finally, for 2012, the credit cannot be claimed if one earns over $229,710, and only a partial credit can be claimed if one earns over $189,710.

IS MY ADOPTEE ELIGIBLE?  The child adopted must be under age 18, or must turn 18 in the year the credit is claimed. The government also allows one to use the credit if one adopts any disabled person who is physically or mentally unable to care for themselves.  If the adoption involves a child born outside of the US, the credit can only be claimed if the adoption has been finalized.  If the child is a United States citizen or resident, the adoption credit can be claimed even if the adoption itself is not yet final.

HOW MUCH IS THE CREDIT?

2012 $12,650
2011 $13,360
2010 $13,170
2009 $12,150
2008 $11,650
2007 $11,390
2006 $10,960
2005 $10,630
2004 $10,390
2003 $10,160

 

HOW DOES ONE CLAIM THE CREDIT?  One must complete Tax Form 8839, the Qualified Adoption Expenses Form, and attach it to the standard 1040 Tax Form. Form 8839 has its own separate instruction form obtainable through the IRS website (http://www.irs.gov/pub/irs-pdf/i8839.pdf). Because Form 8839 requires carrying over certain numbers from Form 1040, it is best to complete them together and file in the year the adoption is finalized.

WHAT DOCUMENTS DOES ONE NEED TO FILE WITH FORM 8839?  It depends on whether the adoption has been finalized or not. If using an accountant, the following forms should be provided to the accountant for submission. Not all of the forms have to be submitted, but the more that are submitted, the fewer problems one could potentially face in the future.

For a domestic adoption that has not yet been finalized: (1) an adoption taxpayer identification number, (2) a completed home study by an authorized placement agency, (3) the placement agreement with an authorized placement agency, (4) any hospital document indicating release of the newborn child to the taxpayer for legal adoption, (5) a signed and sealed court document indicating approval of placement of the child with the taxpayer, and (6) an original affidavit or notarized statement from an adoption attorney or other authorized person stating the signer placed or is placing the child with the tax payer for legal adoption, or is facilitating the adoption process for the taxpayer in some official capacity.

For domestic and foreign adoptions that have been finalized in the US: (1) an official, signed and sealed copy of the adoption order or decree, (2)  a signed and sealed copy of a foreign adoption decree, if available, (3) the child’s visa, and (4) if the adoption was pursuant to the Hague Convention, the Hague Adoption Certificate.

SOME SPECIFICS

WHAT IF MY EMPLOYER CONTRIBUTED TO ADOPTION COSTS?  This is allowed and the credit can still be claimed.  An example that best illustrates how this works:  let us assume that the adoption was finalized in 2012.  Looking at the table above, one would see that the credit would cover qualified expenses up to $12,650; but $20,000 was spent in qualified adoption expenses. One’s employer contributed $5,000 to the process.  One would then have to subtract the $5,000 from $20,000, leaving one with $15,000 in uncovered qualified adoption expenses. Now one can apply the credit because one still has $15,000 in qualified adoption expenses that were not covered by the employer, which can still be offset by the credit amount for 2012.  If one subtracts $12,650 from $15,000, all of the credit would be used.  In sum, costs covered by the employer reduce the dollar amount of the qualified expenses to which one applies the tax credit to.

CAN ONE APPLY FOR THE TAX CREDIT IF ONE DIDN’T KNOW ABOUT IT BEFORE AND MY ADOPTION WAS FINALIZED IN A YEAR WHEN THE CREDIT APPLIED?  It is possible to apply for the credit if one didn’t know of its existence when one first adopted, but one can only go back as far as 2003.  Be aware that the further back one intends to claim the credit, the more complex the process becomes. There are certain specifics that make this answer more complex than it seems. If, for example, one adopted in either 2008 or 2009, but did not claim the credit, one must file the credit in the year the adoption was finalized. The tax return must be amended for the year the adoption was finalized, and all the following years to carry forward any tax credit amounts not used in prior years. If, however, one adopted between 2005 and 2007 and did not claim the credit, it is much more complex because one is generally not permitted to amend a tax return for credit purposes for longer than the past three years.  But the IRS states that it can be done.  If one adopted between 2003 and 2004 and did not claim the credit, the three year amendment rule still applies.

WHAT WILL THE TAX CREDIT BE AFTER 2011?  Because predicting tax policy is like trying to predict the weather, no one can definitively say what it will be in 2013.  There are indications the income limits will be significantly lowered in 2013, and the credit itself will most likely only be applicable to the adoption of special needs children.  The credit will expire for all other types of currently covered adoptions on December 31, 2012, unless the law changes.