TAXES?! Superb Info on the Adoption Tax Credit

“Any one may so arrange his affairs that his taxes shall be as low as possible; he is not bound to choose that pattern which will best pay the Treasury; there is not even a patriotic duty to increase one’s taxes.”  Gregory v. Helvering, 69 F.2d 809, 810 (2d Cir. 1934).

 

Ahhhhh, winter is finally starting to release its icy grip, baseball players are reporting for duty, and it is that time of year when you take deep breath and . . . do your taxes.

 

The good news is that as an adoptive parent, this should be a good tax year for you! 

 

DISCLAIMER: There are attorneys who work in the courtroom and attorneys who do not but are good at helping you stay out of the courtroom and/or saving you money.  I do more of the former than the latter, and I am neither a tax attorney nor a CPA.  So please, please, realize that specific tax questions about how the adoption tax credit may impact your tax situation should be addressed to a qualified tax advisor.  Like all my blog posts, this is for educational purposes, not legal advice.

 

What is the Adoption Tax Credit?  The Adoption Tax Credit is a section of the Internal Revenue Code that allows most American adoptive parents to take a tax credit on their federal income tax return for“qualified adoption expenses” paid to adopt an “eligible child” and an exclusion for employer-provided adoption assistance. 

 

Why does the Adoption Tax Credit exist?  The adoption tax credit has been around since 1997.  Its purpose is to encourage adoption and to help offset costs to low- and middle-income families.  According to Department of Health and Human Services, a third of all adopted children live with families whose annual household income is at or below 200% of the poverty level.  Despite the misconception that usually wealthy families adopt, nearly 46% of families adopting from foster case are at or below 200% of the federal poverty level.  Lawmakers claim the promotion of adoption as “one of the most important things” to strengthen American families.  Here is a link to more detailed information about the Adoption Tax Credit: http://www.irs.gov/taxtopics/tc607.html

 

I thought the Adoption Tax Credit died in 2012?  The adoption expense tax credit was set to expire at the end of 2012.  It was a close call, but rumors of its death were greatly exaggerated.

 

Thanks to the advocacy of, among others, the American Academy of Adoption Attorneys (AAAA), the credit is now “permanent,” meaning it will extend automatically from year to year without Congress needing to renew it every few years. Congress now would have to pass a new provision in the law for the Adoption Tax Credit to cease to be available to adoptive families.  This was part of the fiscal cliff legislation, passed by Congress and signed into law on January 2, 2013.  (American Taxpayer Relief Act of 2012 [Pub. L. No. 112-240])          

 

All of the ground rules remain the same as they were for the 2012 tax year except that the amount of the maximum credit increased, as did the numbers that define the lower and upper limits of income eligibility. All three of these numbers are adjusted each year in accordance with the cost of living.  The maximum credit for 2013 was $12,970 (up from the 2012 number of $12,650).

How much is the adoption tax credit now?  For taxable years beginning in 2014, the credit allowed for an adoption of a child with special needs is $13,190; the maximum credit allowed for other adoptions is the amount of qualified adoption expenses up to $13,190.

 

Therefore, if you are adopting through foster care, you should not have to pay in any taxes unless your tax liability exceeds $13,190, even though you may have paid nothing for the adoption because of your subsidy. 

 

If you adopted privately and have qualified adoption expenses, then you should not have to pay in if your adoption expenses exceed your tax liability for that year.

 

Keep in mind, however, this is per adoption attempt for an eligible child.  This can get a little more confusing if your adoption spans calendar years.  (See the “carrying forward” question below). 

 

What is a “Qualified Adoption Expense”?  Qualified adoption expenses for both the credit and the exclusion include reasonable and necessary adoption fees, court costs, attorney fees, traveling expenses (including amounts spent for meals and lodging while away from home) and other expenses that are directly related to and for the principal purpose of the legal adoption of an “eligible child.”

 

What is an “Eligible Child”?   An eligible child must be under 18 years old, or be physically or mentally incapable of caring for himself or herself.

 

Can I claim the Adoption Tax Credit for any adoption?  No.  It is not available for stepparent adoptions nor most adult adoptions.

 

May I carry the credit forward in order to use it all up?  Yes, but the dollar limit for a particular year must be reduced by the amount of qualified adoption expenses used in the previous years for the same adoption effort.  This is best explained by an example:

 

Jonathan and Martha Kent spent $3,000.00 in 2013 for a homestudy, criminal background checks and attorney fees to adopt their son, Clark, and claim the $3,000 as a credit on their 2013 return.  The Kents spend another $13,000 on Clark’s adoption in 2014, when it becomes final.  The maximum credit the Clarks can claim on their 2014 return will be $10,190 ($13,190 dollar limit, less $3,000 of qualified adoption expenses claimed in 2013).

 

So if my Adoption was not a stepparent or adult adoption, I can claim the credit?  Probably, unless your modified adjusted gross income exceeds $234,580, in which case the tax credit phases out completely.  The credit starts phasing out around $194,580. 

 

We spent money this year on a failed adoption.  Can I claim the credit?  Probably yes.  There are reasons, however, why you might not want to (see below).  Talk to your attorney or tax professional.

 

           

How do I claim the adoption tax credit?  The adoption credit is calculated on Form 8839 Qualified Adoption Expenses (PDF). That form, a publication explaining how to complete Form 8839, and additional information on the adoption tax credit can be found on the IRS website at www.irs.gov

 

Is the tax credit “refundable”?  Not anymore.  This was one of the concessions make to preserved the Adoption tax credit.  For tax years 1997 through 2009, the credit was non-refundable.  It was refundable (meaning taxpayers could receive payments over and above their tax liability) for two years, 2010 and 2011, but it is not a part of the current law.  For the 2012 tax year, the credit reverted to being non-refundable, with a maximum amount (dollar limitation) of $12,650 per child.

 

Am I asking for an audit?  Well . . . unfortunately that is a legitimate concern, though I believe less so starting in 2013 and moving forward.  Here is why I think that, but remember, I do not work for the IRS nor am I a tax attorney, so take this for what it is worth:

 

In 2010 and 2011, when the credits were refundable, this led to a drastic increase in refunds and more families eligible for much larger returns than in previous years.  This did not go unnoticed by the IRS.  In 2011 approximately 68% of returns that claimed the credit were audited and 90% were flagged for further review in 2012.  By contrast, usually only 1% of all returns are audited.  So, yeah, there seemed to be a pretty strong cause/effect relationship.  This also did not escape the radar of the American Academy of Adoption Attorneys, who asked for a review that resulted in some problematic findings for the IRS. 

 

Relatively speaking, very few of the increased audits resulted in additional tax liability.  The IRS came under heavy scrutiny for this practice, and paid over two million dollars in interest for holding up legitimate refunds due to the delay of the additional audits.  Therefore, going forward, I am cautiously optimistic that claiming the adoption tax credit will not be the “red flag” it has in the past.  The credit is once again non-refundable, and therefore the 2010 and 2011 refunds will hopefully be considered a two year anomaly.

 

What records do I need to keep, and what records do I need to file?  To answer the last question first, there is no longer a requirement to attach the adoption documentation to your tax returns (another reason why I think the IRS may not scrutinize these returns as much).  However, documentation must be kept as part of a taxpayer’s records.  If in doubt, if you are going to claim it, you need to have a paper record of it. 

 

Also, keep in mind that most state courts have very confidential and sealed adoption files, and it is not always easy to get copies of needed court documents that will be required at tax time after the fact.  A little advance preparation will make the tax season an easier one for you, your tax preparer and for the IRS and will likely speed up your refund.  Every Spring my office receives a frustrating flood of phone calls from February through April requesting copies of court documents, invoices, etc.  These are things your attorney should be sending you all along.  Keep careful track of them.

 

However . . .

 

Can I claim a flat credit (without the need to show actual expenses) for the adoption of a special needs child?  Yes.

 

Happy number crunching!

 
Joe Hensley is an attorney with offices in Joplin and Carthage, Missouri.  His practice includes civil trials and litigation, with an emphasis on adoptions.  He is the former Chief Legal Counsel for the Jasper County Juvenile Office and is a member of the American Academy of Adoption Attorneys.