The adoption tax credit is an important federal tax benefit and can have a significant financial impact for many adoptive parents. To take advantage of this benefit you must understand what it is, which expenses are eligible, and what you need to do to receive a refund.
This article provides an overview of some of the most important elements of the adoption tax credit and is for informational purposes only. We are not offering tax advice and encourage you to always seek the expertise of an accounting professional.
What is the adoption tax credit?
The adoption tax credit is an increase in your Internal Revenue Service (IRS) year-end tax refund based on the amount of tax credit requested. You can request 100% or a dollar-for-dollar tax credit of the amount of qualified adoption expenses you incur during a domestic or international adoption.
For adoptions finalized in 2019, there is a federal adoption tax credit of up to $14,080 per child. The adoption tax credit is eliminated when adjusted gross income exceeds $251,160. These amounts change annually. The adoption tax credit is limited when no income taxes are incurred, but the tax credit will carry forward for 5 years until used up by taxes incurred.
Which adoption expenses are allowable under the law?
Qualified adoption expenses are very specific and directly related to the adoption process. Adoption fees, attorney fees, court costs, and adoption-related travel costs are eligible expenses. Any reasonable amount incurred that is directly related to the adoption of a qualified child (a qualified child is under 18 or disabled), including costs associated with the training, profile, and advertising services offered by My Adoption Advisor, are also eligible expenses.
Birth mother expenses are allowable if directly related to the adoption. The IRS will question these expenses so you should document them well and make as clear as possible the direct relationship to adoption.
Unallowable expenses are expenses unrelated to the adoption, such as daycare, formula, a stroller, or furniture for the nursery. Expenses reimbursed by government funds or by an employer are also not allowed.
When can I claim the credit for my allowable expenses?
For domestic adoption, the qualified adoption tax credit is taken in the tax year after payment is made unless the adoption becomes final, in which case it is taken in the same year payment is made. Failed domestic adoptions qualify for the tax credit, but adoptions by a spouse do not qualify.
The tax credit rules for international adoptions are different and expenses are only claimed in the year the adoption becomes final. The credit may be taken in several tax years, but the per child limit is cumulative.
When someone adopts a special needs child as certified by the state, the adopting parents get the full tax credit even if they didn’t incur expenses. This credit is decreased by any prior year tax credits claimed for this child.
What documentation should I keep (and for how long)?
You should keep all financial records, legal agreements, and written adoption paperwork, including home study paperwork. Financial records include invoices, bank statements, and copies of written checks.
Most audits in adoption tax credit matters are done by correspondence so in the case of an audit, you and your accountant will typically communicate with the IRS by mail and fax.
Tax audits can only occur for 3 past tax years so you only need to retain records related to adoption expenses for 4 years.
The Adoption Tax Credit: An Example
Let’s use an example to further clarify some of the aspects of the adoption tax credit. Assume the following for this example:
Sharon is pursuing a domestic infant adoption (international and special needs adoptions are handled differently, so this starting point is important). She makes $100,000 per year and incurs $9,000 of federal income tax per year. Her typical federal income tax refund is $500 so we’ll assume this refund occurs each year.
In the fall of 2016, Sharon begins the adoption process by paying an attorney $200 to learn about adoption. She ultimately decides to sign up with an adoption agency and pays $5,000 for a home study, adoption training, and other support services.
2016 Tax Implications
Sharon’s 2016 tax filing does not include forms related to the adoption tax credit because a qualified adoption tax credit is taken in the tax year after payment is made unless the adoption becomes final (in which case it’s taken in the same year as payment is made).
In the spring, Sharon matches with an expectant mother. For 2 months she pays the expectant mother a total of $800 for expenses that are allowed by her state. The expectant mother ultimately decides to parent her child.
In the fall, Sharon has to pay her agency $500 for an updated home study. She also hires an adoption consultant who helps her create a new adoption profile and an adoption website. Those services cost $1,500.
2017 Tax Implications
Sharon’s 2017 tax filing has a $5,200 adoption tax credit request for the attorney and agency fees she paid in 2016. As a result, her refund is $5,700 ($5,200 plus her assumed $500 refund).
In early summer, Sharon hires a consultant to run an online advertising campaign to drive more traffic to her website. She pays the consultant $900 for this service and ultimately pays Google $1,200 in advertising expenses.
In the fall, Sharon matches with another expectant mother. She takes placement of her child in the winter and pays her adoption agency a $12,000 placement fee.
2018 Tax Implications
Sharon’s 2018 tax filing has an $800 adoption tax credit request for the first child for the birth mother expenses she incurred. She also has a $2,000 adoption tax credit request for the second child for the agency fee for her updated home study and for the profile and website services provided by the consultant. Her refund is $3,300 ($800 plus $2,000 plus her assumed $500 refund).
Sharon finalizes her child’s adoption in June. She incurs $1,000 in court and legal fees.
Her employer has a benefit that reimburses her $5,000 for expenses related to the adoption. She receives that payment in the fall.
2019 Tax Implications
Sharon’s 2019 tax filing has a $10,100 adoption tax credit request: $900 for a consultant plus $1,200 for advertising expenses plus $12,000 for her agency placement fee plus $1,000 for court and legal fees LESS the $5,000 that was reimbursed by her employer.
Her tax refund in 2019 is only $9,500, however, because the refund cannot exceed the amount of taxes paid. As stated at the beginning of the example, she pays $9,000 in federal income tax and gets $500 returned.
As a result of not paying enough in taxes to receive the entire benefit in 2019, she also gets an adoption tax credit carry-forward to 2020 of $2,640. This is calculated by reducing the $9,000 federal income taxes by $1,540 due to her new dependent (since the adoption was finalized during the first half of the year). When you subtract the difference, $7,460, from the initial request of $10,100, the result is $2,640.
The $5,000 employer reimbursement is reported on her 2019 tax return and is tax free, but it is required to be disclosed and justified.
Adoption tax credits are very complex and the IRS reviews a significant portion of claims. Please document your claim carefully and hire a professional Certified Public Accountant (CPA) or Enrolled Agent (EA) with experience in preparing adoption tax credit claims to assist you.
The following resources provide additional information on the Adoption Tax Credit: