Adoption is a beautiful way to build and grow a family, but it’s no surprise that the process can be costly. To provide some relief from the expenses adoptive parents incur when adopting a child, the IRS offers a tax credit that can help ease the financial burden of adoption. With tax season upon us, please feel free to share the following important and interesting things about the adoption tax credit with your clients.
One – What it is:
The IRS tax credit is a dollar-for-dollar reduction of adoptive parents’ total tax liability for qualified adoption expenses paid to adopt an eligible child. The tax credit can be used to directly reduce adoptive parents’ total tax liability.
In addition to the tax credit, some employers offer adoption assistance programs to help employees cover the costs of adopting a child. The amounts provided through these employer programs may be excluded from the employee’s gross income, effectively reducing their taxable income.
In addition to this exclusion, adoptive parents may claim the adoption tax credit for the remaining amount of adoption expenses. It is important to note that adoptive parents may not claim the tax credit and the exclusion for the same expenses.
Two – Income and Dollar Limitations:
Both the adoption tax credit and the exclusion are dependent upon income and dollar limitations.
Income Limitation: The income restriction for the adoption tax credit and exclusion is determined by the adoptive parents’ modified adjusted gross income (MAGI). For the year 2023, if their MAGI fell below $239,230, they are eligible for both the tax credit and the exclusion. If their MAGI was more than $239,230 but less than $279,230, they will receive a reduced tax credit. If, for the tax year 2023, their MAGI was $279,230 or more, they are not eligible for the tax credit or exclusion.
The income restriction has changed for this current year. For the year 2024, if the adoptive parents’ MAGI is equal to or less than $252,150, they are eligible for both the tax credit and the exclusion. If their 2024 MAGI is more than $252,150 but less than $292,150, they will receive a reduced tax credit. If their MAGI is $292,150 or more in 2024, they will not be eligible for the tax credit or exclusion.
Dollar Limitation: The dollar limitation applies to both the tax credit and the exclusion. Adoptive parents must first claim the exclusion from income before claiming the allowable tax credit. The allowable tax credit for 2023 is $15,950. In 2024, to adjust for inflation, the adoption tax credit increases to $16,810.
Three – Qualified Expenses:
For both the tax credit and the exclusion, the IRS defines qualified adoption expenses as any reasonable and necessary expenses directly related to the legal adoption of any child including:
- Court costs and attorney fees
- Agency fees and homestudy costs
- Travel expenses (including airfare and meals and lodging while traveling away from home)
- Other expenses directly related to, and whose principal purpose is for, the legal adoption of an eligible child
An expense may qualify as an adoption expense even if it is paid before a child has been identified for adoption or if an adoption situation fails.
Four – Timing:
If the child is born in the United States or is a resident alien, adoptive parents can claim the adoption tax credit in the year after they incurred the expenses. If, however, the adoption process finalizes in the same year they incur the expenses, they may claim the adoption tax credit in that year. In addition, if the adoptive parents incur additional expenses in the year after the completion of the adoption process, they may take the tax credit in the same year they incurred the expenses. In an international adoption, adoptive parents may only claim the adoption tax credit after the adoption is finalized.
The adoption tax credit is nonrefundable, meaning it can only reduce their tax liability to zero. If the credit exceeds the adoptive parents’ tax liability for the year, they can carry forward the excess credit for up to five years, allowing them to potentially use it in future years.
Five – Eligibility:
Eligibility for the tax credit is not contingent upon a successful adoption. In fact, expenses related to the attempted adoption of a specific child, regardless of the success, can be reimbursed through the tax credit. The IRS allows adoptive parents to treat these adoption expenses in the same manner as expenses they paid for an adoption that was not finalized by the end of the year.
The IRS defines an eligible child as any person under the age of 18 or any person who, regardless of age, qualifies as disabled and physically or mentally unable to take care of themselves. It is important to note that the tax benefit does not apply to a child of one’s spouse, so adopting one’s stepchild would not make the adoptive parents eligible for the tax credit. The tax credit does apply, however, if a domestic partner adopts as a second parent or co-parent.
THIS MEMO IS NOT TAX ADVICE. Adoptive parents should consult with a tax professional to determine the extent of the adoption tax credit and exclusion available to them.