Written by Richelle Maguire, CPA
So much attention is paid to the personal and emotional aspects of adoption, but adoptive parents are often left to our own devices to deal with the financial and possible tax implications associated with the adoption of a child. Understanding the adoption tax laws will enable you to not overlook possible financial benefits available to you.
Tax benefits for adoption include both a tax credit for qualified adoption expenses paid and an exclusion for employer-provided adoption assistance. The tax credit is nonrefundable, which means it is limited to your tax liability for the year. The maximum credit (dollar limit) for 2019 is $14,080 per child. For 2020, this amount is increased to $14,300. This amount is indexed annually for inflation.
For both the credit and the exclusion, qualified adoption expenses include:
- Reasonable and necessary adoption fees,
- Court costs and 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.
The credit and exclusion are each subject to an income limitation and a dollar limitation. The income limit on the adoption credit or exclusion is based on your modified adjusted gross income (MAGI). Modified adjusted gross income (MAGI) is simply your adjusted gross income (AGI) for the tax year subject to certain adjustments.
For tax year 2019, the MAGI phase-out begins at $211,160 and ends at $251,160. Thus, if your MAGI amount is below $211,160 for 2019, your credit or exclusion will not be affected by the MAGI phase-out, but if your MAGI amount for 2019 is above $251,160, your credit or exclusion will be zero. These amounts are indexed for inflation.
You must reduce the dollar limit for a particular year by the amount of qualified adoption expenses used in previous years for the same adoption effort. For example, if you claimed a $3,000 credit in connection with a domestic adoption in 2018 and paid an additional $30,000 of qualified adoption expenses in 2019, the maximum credit you can claim in 2019 is $11,080 ($14,080 dollar limit, less $3,000 of qualified adoption expenses claimed in 2018).
The dollar limitation applies separately to both the credit and the exclusion, and you may be able to claim both the credit and the exclusion for qualified expenses. However, you must claim any allowable exclusion before claiming any allowable credit. Expenses used for the exclusion reduce the amount of qualified adoption expenses available for the credit. As a result, you cannot claim both a credit and an exclusion for the same expenses.
The tax year for which you can claim the credit depends on when the expenses are paid and whether the adoption has finalized in the year. For domestic adoption, qualified adoption expenses paid before the year the adoption becomes final are allowable as a credit for the tax year following the year of payment (even if the adoption is never finalized). Once an adoption becomes final, qualified adoption expenses paid during or after the year of finality are allowable as a credit for the year of payment. Because of these timing rules, a taxpayer may sometimes claim a credit for both prior-year and current-year qualified adoption expenses in the year of finality.
To claim the adoption credit or exclusion, complete Form 8839, Qualified Adoption Expenses, and attach the form to your Form 1040, U.S. Individual Income Tax Return. There is no longer a requirement to attach the adoption documentation with your tax return. However, you must keep the documentation as part of your records. Although you may usually prepare your own tax returns, as filing requirements are complicated in this area, you may wish to consider consulting with a professional tax return preparer.
In December of 2019, Congress passed The Setting Every Community Up for Retirement Enhancement Act or The SECURE Act. This new legislation, allows taxpayers who adopted a child to take a withdrawal of up to $5,000 (up to $10,000 per couple if both spouses have an eligible retirement account) from their retirement accounts, including a 401(k) or IRA, without the typical 10% early withdrawal penalty. Distributions are subject to regular income tax.
In addition to the Federal adoption tax benefits available, Massachusetts also provides tax benefits for adoption. If you paid adoption fees to a licensed adoption agency during 2019, you are eligible for an exemption of the total amount of the fees paid during the year. This exemption equates to a 5.05% state subsidy at the current individual income tax rate for 2019. Contrary to the federal rules, the Massachusetts adoption tax benefit is available in the year of payment without regard to whether the adoption has become final.
Are you interested in adopting in Massachusetts? Contact Adoptions With Love to learn more.