Know Your Tax Credits - The Adoption Credit
by John Cooney on Mar 10, 2020
As we move towards April 15th’s tax filing deadline, I wanted to spend a few blogs explaining some of the tax credits that may be available to you. We have previously gone over the American Opportunity Tax Credit (AOTC) and the Lifetime Learning Credit (LLC). Today, we will go over the adoption credit, who can claim it, what they can claim, and how to make the claim.
When Can You Claim The Adoption Credit?
Claiming the adoption credit depends on three things:
- When the expenses are paid
- Whether it is a domestic or a foreign adoption
- If it is domestic, expenses paid prior to the year the adoption becomes final are allowable as a credit for the tax year following the year of payment (even if the adoption is never finalized)
- If it is a foreign adoption, expenses paid before and during the year are allowable as a credit for the year when it becomes final
- When, if ever, the adoption is finalized
- What year to claim the expense in can be confusing, use this chart to help you determine what year to take the credit in
- The adoption credit is a non-refundable credit, which means if you do not owe taxes, you can not claim the credit; the good news is you can carry forward any unused credit amount until it is used or for 5 years, whichever comes first
What Are Qualified Adoption Expenses?
- Reasonable and necessary adoption fees
- Court costs and attorney fees
- Travelling expenses (including amounts spent for meals and lodging while away from home)
- Other expenses that are directly related to and for the principal purpose of the legal adoption of an eligible child; an eligible child is an individual who is under the age of 18 or is physically or mentally incapable of self-care
- It is important to note that expenses paid for adopting the child of a taxpayer’s spouse do NOT qualify for the adoption credit
- Qualified expenses must also be reduced by any employer-provided benefits the taxpayer may have received for the adoption, although you may also be able to exclude those benefits from your income
What Are The Income Limits?
- For 2019, the income phase-out for the adoption credit is $211,160 to $251,160.
- That means the credit is 100% available for taxpayers whose Modified Adjusted Gross Income (MAGI) was under $211,160 and not available for taxpayers whose MAGI was above $251,160
- For those whose MAGI fell in-between $211,160 and $251,160, they would be eligible for a portion of the credit
- For example, take a couple whose MAGI is $231,160 and who had qualified adoption expenses of $10,000. To determine how much they can claim, you subtract $211,160 from their MAGI of $231,160 and then divide that number by $40,000; so in this case, $20,000/$40,000 equals 50%, and the couple could claim $5,000 of the adoption credit, which is 50% of $10,000
- For 2020, the income phase-out limit was raised to be from $214,520 to $254,520.
How Much Can You Claim?
- The adoption credit is limited per child, in 2019 that limit was $14,080 and was raised to $14,300 for 2020
- While the limit is per child, it is a lifetime limit per child, for example
- If a taxpayer claimed $8,000 in expenses in 2018, they would be limited to claiming only $6,080 in 2019 ($14,080 - $8,000)
How Do You Claim It?
- The adoption credit is claimed by filing IRS Form 8839 with your tax return
- Form 8839 is also used to exclude any employer benefits paid to you or on your behalf for an adoption
- Make sure you are keeping track of your adoption related expenses and have the back-up documents available as part of your records
The SECURE Act and Adoption
- While not directly related to the adoption credit, I did want to address an adoption related change to tax law
- The SECURE Act, passed at the end of 2019, included a provision aimed at assisting new parents, whether biological parents or adopting parents
- The SECURE Act added a new exemption category, allowing taxpayers to withdraw up to $5,000 from a retirement account (such as 401ks and IRAs) without incurring an early withdrawal penalty
- The distribution needs to be within one-year of the birth or adoption being finalized
- The taxpayer can repay the distributed amount in the future and those contributions will be treated as a rollover amount, ie it will not count towards contribution limits for the year it is repaid
Did you adopt or are you planning to adopt a child in the future? Don’t let these expenses hit your wallet twice. We are here to answer your adoption credit questions and help you reduce your tax liability so you can spend that money on your kids! You can set-up a complimentary tax planning meeting by contacting me at email@example.com.