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.