The Tax Benefits of Adoption

At The Yeatts Law Firm, it is a great privilege to assist our clients with growing their families through adoption. However, one of the hurtles for many prospective adoptive parents is the costs associated with the adoption process. Many of our clients are surprised to learn that there are several adoption tax credits and benefits that may be able to offset adoption expenses.

The Federal Adoption Tax Credit

Many adoption costs can be offset through the Federal Adoption Tax Credit, which was made permanent in 2013. For adoptions finalized in 2014, the maximum tax credit available is $13,190 per child. This tax credit is nonrefundable, which means that only those individuals with federal income tax liability (see the example below) will benefit.

To be eligible for the Federal Adoption Tax Credit, parents must:

  • Have adopted a child other than a stepchild - The credit applies to all types of adoption (except stepparent adoption), including international, domestic private, and public foster care. A child must be either under 18 or by physically or mentally unable to care for him or herself.
  • Be within the income limits - In 2014, families with a modified adjusted gross income below $197,880 can claim the full tax credit. Those incomes above $237,880 cannot claim the credit; those with incomes from $197,880 to $237,880 can claim partial credit.
  • Only refunds qualified adoption expenses, unless the child is special needs 

What does it mean that the credit is nonrefundable?

A non-refundable tax credit is one in which taxpayers receive a refund of federal income taxes, but only up to the amount of taxes they otherwise had due.  In one year, taxpayers can use as much of the adoption tax credit as the full amount of their federal income tax liability.

Example - A family has $6,000 in federal income taxes withheld from their paychecks during the year. After they do their taxes, they look at the tax tables and based on their adjusted gross income, their federal income taxes are $2,000 (this is their tax liability). If there was no adoption tax credit, they would be due a refund of $4,000. However, they have qualified adoption expenses of $8,000. Because of the adoption tax credit, they would be eligible to receive an additional $2,000 for that tax year (reducing their tax liability to zero), meaning that they can get the full $6,000 that was withheld back rather than just the $4000 they would have gotten without the non-refundable adoption tax credit. 

Additionally, they can carry the remaining $6000 ($8,000 in expenses minus the $2,000 they received) forward to future years and receive additional refunds depending on their tax liability in future years. 

What are qualified adoption expenses?

The IRS writes, "Qualified adoption expenses are reasonable and necessary expenses directly related to, and for the principal purpose of, the legal adoption of an eligible child.

Qualified adoption expenses include:
  • Adoption fees,
  • Attorney fees,
  • Court costs,
  • Travel expenses (including meals and lodging) while away from home, and
  • Re-adoption expenses relating to the adoption of a foreign child.
Qualified adoption expenses do not include expenses:
  • For which you received funds under any state, local, or federal program,
  • That violate state or federal law,
  • For carrying out a surrogate parenting arrangement,
  • For the adoption of your spouse's child (step-parent adoptions are excluded),
  • Paid or reimbursed by your employer or any other person or organization, or
  • Allowed as a credit or deduction under any other provision of federal income tax law."

What if the adopted child is special needs?

The maximum $13,190 tax credit will remain flat for special needs adoptions (those involving children who are deemed hard to place by a child welfare agency), allowing those families to claim the maximum credit regardless of whether they had qualified adoption expenses at all.The credit is still nonrefundable for special needs adoptions.

Alabama's New State Adoption Tax Credit

Effective for 2014 and forward, Alabama families that adopt children who are in the state's foster system or are residents of Alabama (and their mothers are residents, too) are eligible to receive a $1,000 refundable state tax credit. Plus, if the child is 14 or older, $15,000 is available for use towards post-secondary education at an Alabama school. Because this credit is refundable, the adoptive parent can receive the credit regardless of their tax liability. It is treated as a payment so the parent can receive a refund larger than any taxes they have paid during the year.

Dependency Tax Exemption

Adoptive parents may take the same dependency exemption on their income taxes for adopted children (and children placed with them in a not-yet-finalized adoption) as they would for biological children. The exemption reduces taxable income. Families must provide more than half of a child's support to list the exemption.

    For more information on the adoption tax credit and exclusion, contact The Yeatts Law Firm today!