Adoption is a great way to add to your family. Whether you are just starting your family, or wanting to expand, adoption is an excellent way to give a child a home. The IRS makes it even easier by giving you a tax credit to help with the costs. The credit is reported on Form 8839 and submitted with your personal income tax return.
For adoptions finalized in 2021 the credit can be as much as $14,440 per child. For adoptions finalized in 2022 this amount will be $14,890. The credit covers the adoption expenses, which include reasonable and necessary adoption fees, court costs, attorney fees, and travel expenses (including meals and lodging while away from your home). The maximum credit is limited to your actual expenses. If you adopt a special needs child, you can claim the full amount of credit whether or not you actually have expenses. For these purposes, a special needs child is defined by the IRS as a child in U.S. foster care who receives an adoption subsidy or assistance, or reimbursement of adoption assistance. Not every child adopted through the foster care system is considered special needs – if the state does not provide assistance, then the child is not considered special needs. This also means that a child who has a disability is not necessarily considered special needs, and no child adopted internationally is considered special needs.
This credit will go against your tax liability, but it is not refundable. So, if your tax liability on your tax return is less than your credit, the excess is carried forward. For example, when you finish your tax return and your total tax is $9,000, the credit will wipe out the $9,000 tax, and you would carryover the remainder of the credit to the following tax year. The excess can be carried forward for up to five additional years.
There are some rules to follow. This credit does not cover the adoption of a stepchild. The child must also be under the age of 18, unless they are physically or mentally unable to take care of themselves. For tax year 2021, in order to claim the credit, your modified adjusted gross income (MAGI) must be below $216,660. Modified adjusted gross income is your adjusted gross income before you add back your student loan interest deduction, foreign earned income, housing deduction, excluded savings bond interest, and a few other of the adjustment to income items. The credit then begins to be phased out and is totally phased out once your income exceeds $256,660. For tax year 2022, IRS has announced that the phase out begins at $223,410 and is completely phased out at $263,410. Once your MAGI exceed the threshold, no credit will be allowed, nor could it be carried forward. For planning purposes, you need to make sure your MAGI is below the threshold in the year you adopt.
If your employer provides adoption benefits, then you must account for that by reducing your expenses by the amount provided. Parents who are adopting a special needs child (since they can claim the full amount regardless of actual expenses) should claim the credit in the year the adoption is finalized. Parents who are adopting from another country must also claim the credit in the year it is finalized. For domestic adoptions, you can claim the credit in the year it is finalized or the year after you spent the funds. For example, a domestic adoption had expenses in 2019, 2020 and 2021, and the adoption is finalized in 2021. The 2019 expenses can be claimed on the 2020 return (the year after they spent the funds), and the expenses paid in 2020 and 2021 would both be claimed on the 2021 return (the year after for the 2020 expenses, and the year finalized for the 2021 expenses).
In domestic adoptions, even failed adoptions can qualify for the credit. You must, however, wait one year after you incur the expenses in order to claim the credit. If you later successfully adopt, you cannot claim the credit twice, so you will combine the expenses for both the failed and successful adoption on Form 8839 and list the combined costs under the Child 1 column.
Adoption can be a scary road, almost as scary as preparing your taxes. Here at ADKF we are here to help you with confusing aspects of this tax credit.