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Adopting a child is not only a deeply fulfilling journey but also a significant financial commitment. Recognizing the expenses involved, the IRS provides various tax benefits to help offset adoption costs, including credits and exclusions. Here’s an overview of the key tax advantages available to families adopting a child.
1. Adoption Tax Credit
The Adoption Tax Credit is one of the primary financial reliefs available to adoptive families. For the 2023 tax year, the maximum adoption tax credit is $15,950 per child. This credit can be used to offset qualified adoption expenses and is available for each child adopted, including special needs adoptions.
Qualified adoption expenses include:
- Adoption fees
- Attorney fees and court costs
- Travel expenses related to the adoption
- Re-adoption expenses for a foreign child
Note: Expenses covered by employer-provided benefits are not eligible for the credit.
Claiming the Adoption Tax Credit
- The adoption tax credit is non-refundable, meaning it can only reduce your tax liability to zero. Any unused portion can be carried forward for up to five years.
- For domestic adoptions, families can start claiming the credit in the year the adoption is finalized. If the child has special needs, the credit may still be claimed even if no expenses were incurred.
2. Employer-Provided Adoption Assistance Exclusion
Many employers offer adoption assistance programs to help cover the costs of adoption. Through these programs, families can exclude employer-provided adoption assistance from their gross income, up to $15,950 per child (for 2023).
How It Works:
- This exclusion applies to eligible adoption expenses covered by the employer’s adoption assistance program.
- Like the adoption tax credit, this exclusion is subject to income phase-out limits. For 2023, the exclusion begins to phase out at $239,230 in modified adjusted gross income (MAGI) and is fully phased out by $279,230.
3. Special Rules for Special Needs Adoptions
Families who adopt children with special needs may qualify for the maximum adoption credit, even if they did not incur specific adoption expenses. A special needs child, for tax purposes, is one whom a state child welfare agency has determined:
- Cannot or should not be returned to their parents’ home,
- Has a condition or factor making it unlikely that the child will be adopted without assistance.
This provision allows families adopting special needs children to claim the full credit amount, helping make adoption more accessible.
4. Income Limitations and Phase-Outs
Both the adoption tax credit and the employer-provided adoption assistance exclusion are subject to income phase-out limits. For 2023, if your MAGI exceeds $239,230, these benefits begin to phase out. Families with a MAGI above $279,230 are not eligible.
Example: If your MAGI is close to these thresholds, consider consulting a tax advisor on timing adoption-related expenses. Careful planning might help you qualify for the full benefits.
5. When to Claim the Credit and Exclusion
The timing for claiming the adoption tax credit depends on the type of adoption.
- Domestic Adoption: Qualified expenses can be claimed in the year after they’re paid, even if the adoption is not finalized. Once finalized, all expenses incurred in that year can be claimed.
Example: If you incurred adoption expenses in 2022 for a domestic adoption that finalized in 2023, you could claim those expenses on your 2023 tax return. - Foreign Adoption: For foreign adoptions, the credit can only be claimed once the adoption is finalized.
6. Required Documentation
The IRS may request documentation to substantiate the adoption tax credit, especially in special needs adoptions. Common documentation includes:
- Adoption decree or final adoption order
- Receipts for qualified adoption expenses
- Documentation from the adoption agency verifying the child’s special needs status, if applicable
Pro Tip: Keep detailed records of all adoption expenses and any related correspondence with your employer if using employer-provided assistance.
7. State Adoption Tax Benefits
In addition to federal benefits, several states offer their own adoption tax credits or incentives to encourage adoption. Some states provide tax credits specifically for adopting children within the foster care system. It’s wise to check with your state’s revenue department or consult a local tax professional to explore additional benefits that may be available.
Final Thoughts
The adoption tax credit and employer-provided adoption assistance exclusion can significantly reduce the financial burden of adoption. However, the complexities of these tax rules, especially regarding timing, income limits, and required documentation, mean that many families benefit from consulting with a tax professional. By understanding these IRS tax advantages, families can take full advantage of available tax savings, making adoption more affordable and allowing them to focus on building a loving family.
