As if going through the adoption process isn’t taxing enough, adoptive parents still have big challenges following the placement of a child in their home. They must figure out how this expansion of their family is handled in the context of taxes. Although seemingly complicated, the tax treatment in adoption situations can be grasped by taking a little time to learn more about the tax implications of adoption. Here are the answers to some common tax questions prospective adoptive parents pose.

Is an adopted child my dependent?

A child legally placed for adoption at any time during the year is treated like a biological child for tax purposes. That child may be claimed as a dependent even if he or she did not live with the adoptive parents for the entire year and even if the adoption was not finalized until the following year. Following the finalization of the adoption, the adopted child is always considered the taxpayer’s child going forward. 

What if my child does not have a social security number yet?

Adoption can sometimes be a lengthy process, perhaps spanning more than one year. Thus, it is not an uncommon situation for a child to be placed for adoption in one tax year but the finalization of the adoption does not occur until a subsequent tax year. In those situations, particularly for infants, a Social Security Number may not yet have been issued or the original number is not known to the prospective adoptive parents when it comes time to file taxes. 

Tax laws require a valid identifying number be provided for all persons listed on a federal income tax return. How, then, can prospective adoptive parents claim the child being adopted as a dependent on their tax return if no social security number is available for them? The answer is an Adoption Taxpayer Identification Number (ATIN for short). 

Prospective adoptive parents can apply for an ATIN to begin claiming the child as a dependent when no social security number has been issued or when the number is unknown. Form W-7A, Application For Taxpayer Identification Number, is utilized for this purpose. The IRS can issue an ATIN for adopting taxpayers to use on their tax return to identify a child while a domestic adoption is pending.

The ATIN is only intended for temporary use. The number will be deactivated when the IRS is notified of the child’s Social Security Number. If no notification is forthcoming in two years’ time, the ATIN is automatically deactivated. 

Is adoption assistance from my employer considered taxable income?

According to the Child Welfare Information Gateway, more than 50 percent of employers offer some type of adoption benefit. This benefit may take the form of financial assistance, employee leave, or adoption counseling. For example, the United States Department of Defense has offered reimbursement of adoption expenses up to $2,000 per child as well as parental leave for active-duty military members pursuing non-stepparent adoptions.

One of the tax benefits for adoption is an exclusion from income for employer-provided adoption assistance. Form 8839, entitled Qualified Adoption Expenses, must be completed to determine the permissible amount which can be excluded. The maximum amount allowed to be excluded for tax year 2020 was $14,300. The ability to exclude such amounts from taxable income phases out when certain income levels are reached presumes actual expenditure of the sum sought to be excluded and may be predicated on the employer’s having a written qualified adoption assistance program.

How much is the federal adoption tax credit?

The federal adoption tax credit first became available following the passage of the Small Business and Job Protection Act of 1996. Beginning in 1997, a credit of up to $5,000 was available. That figure rose in subsequent years because it is indexed to inflation; thus, a small increase occurs each year. By 2019, the adoption tax credit had increased to $14,080, and in tax year 2020, it went up to $14,300. The maximum amount will rise by $140 in tax year 2020 to $14,440. 

What if more than one child is adopted in a tax year?

The federal adoption tax credit applies per child adopted. Thus, if more than one child is adopted, such as twins or a sibling group out of foster care, the tax credit can be claimed for each eligible child for the applicable tax year. 

Is the federal adoption tax permanent?

The American Taxpayer Relief Act of 2012 made the federal adoption tax credit a permanent part of the tax code. Permanent in this sense means the tax credit is not scheduled to sunset or be terminated at a specific future point. Nevertheless, future legislation could be passed to alter or eliminate the tax credit.

Is the federal adoption tax credit refundable?

Tax credits may be either refundable or non-refundable. With a refundable tax credit, the taxpayer receives money from the federal government even if he or she owes no taxes. However, most tax credits, including the federal adoption tax credit, are non-refundable. With a non-refundable tax credit, the most it can do is to reduce the taxpayer’s liability to $0. 

Credit in excess of the taxpayer’s tax liability can be carried over for up to five years. Thus, if Mr. and Mrs. Jones are entitled to the full amount of the adoption tax credit of $14,300 for tax year 2020, but their tax liability is only $9,000, the balance of $5,300 ($14,300 – $9,000) can be carried over to tax year 2021 to reduce that year’s tax liability. If their tax liability in 2021 is only $4,000, the $1,300 balance due under the credit ($5,300 – $4,000) can be carried over to tax year 2022. This process continues until either the full amount of the credit is obtained or five years have elapsed.

Why is there a federal adoption tax credit for adoptive parents?

Taxpayers who are not adoptive parents may question why adoptive parents are allowed to take advantage of a several-thousand-dollar tax break when those adoptive parents have a good income. The reason behind the tax credit offered is to promote adoption. The incentive is provided as an encouragement to families to adopt children, especially those children with special needs. Accordingly, adoptive parents of special needs children have claimed the full credit without documenting expenses.

Pursuing the adoption of any child can be an expensive undertaking. Figures reported by the Child Welfare Information Gateway indicate a private adoption can be expensive. These amounts present an economic hurdle for prospective adoptive parents to overcome even if their annual household income is a comfortable $100,000; the cost of the adoption could require approximately half of a year’s income: a deterrent to proceeding.

For what type of adoption may the adoption tax credit be claimed?

The federal adoption tax credit is available for several types of adoptions. It may be claimed in a private adoption, adoption of a child from foster care, adoption of a special needs child, a domestic adoption, and international adoption. Excluded from the tax credit availability are expenses incurred in connection with a stepparent adoption.

Can the federal adoption tax credit be claimed if no taxes are owed?

The concept of a tax credit is a dollar-for-dollar reduction of tax liability. It differs from a tax deduction which merely reduces the amount of income subject to taxation. To reduce tax liability, there must be tax liability in the first place. Therefore, a taxpayer is only eligible to claim this tax credit if he has a federal income tax liability. 

Are there income limits for eligibility to claim the adoption tax credit?

Federal tax laws place a cap on a taxpayer’s income for eligibility to claim the federal adoption tax credit. The income limit is based on Modified Adjusted Gross Income (MAGI). MAGI is the sum of adjusted gross income, tax-exempt interest income, and specific deductions added back in. 

At a certain income level, a phaseout begins for eligibility for the federal adoption tax credit, and the taxpayer is not eligible for the full credit. In tax year 2020, the phaseout begins at the $214,520 level and ends at $254,520. These amounts will increase in tax year 2021 to $216,600 and $256,660. 

What are qualified adoption expenses?

One of the tax benefits which may be available for adoptive parents is a tax credit for qualified adoption expenses paid to adopt an eligible child. To be an eligible child, the adoptee must be under the age of 18 or physically or mentally incapable of self-care. Expenses incurred for a stepparent adoption are not qualified adoption expenses. 

The expense for which reimbursement is sought must be an out-of-pocket expense to qualify for the credit unless the adoption is of a special needs child. Where the adopted child has been determined to have special needs, his or her adoptive parents may claim the full amount of the tax credit regardless of the number of their expenses. The credit for all other adopted children is based on the family’s actual qualified adoption expenses.

The tax code identifies four categories of expenses as qualified adoption expenses. The first category is reasonable and necessary adoption fees. Included in that category would be the cost of a required home study for the prospective adoptive couple to be approved for an adoptive placement. Court costs, such as filing fees, and attorney’s fees are the second category of qualified adoption expenses. The third category is travel expenses connected to the adoption. This category includes amounts spent for lodging and food while away from home in connection with an adoption. For example, an adoptive couple could seek tax credit for their hotel bills and meals while in another state for placement of a child in an interstate adoption. The final category includes other expenses directly related to and for the legal adoption of an eligible child. 

To determine the number of qualifying expenses, the taxpayer should add up all the expenses incurred concerning the adoption. Amounts paid or reimbursed by an employer, government agency, or other organization must then be subtracted from that figure to reach the bottom-line amount of qualifying adoption expenses.

The taxpayer claiming the tax credit must be able to substantiate the expenses claimed. Documentation to do so must thus be retained. For example, the taxpayer should be able to produce receipts to document food and lodging for travel expenses and a bill from the attorney for legal services and court costs in connection with the adoption. 

When can the federal adoption tax credit be claimed?

The federal adoption tax credit is available for both foreign and domestic adoptions. Nevertheless, the timing for claiming this credit depends on the type of adoption. Where an international adoption is involved, the tax credit may not be claimed until the adoption becomes final. In contrast, for domestic adoptions, the tax credit may be claimed in the year after the expenses were paid; however, the tax credit may be claimed in the same year as the expenses were incurred if that adoption was finalized in the same year as the expenses were paid.

Are state adoption tax credits available for adoptive parents?

Some states offer an adoption tax credit. The amount available and the qualifications for eligibility are set by the specific state’s law. 

Is the child tax credit available for adopted children?

The child tax credit aims to help with the numerous expenses of raising children in this country, including the high cost of childcare. This credit is available to taxpayers who have a child under the age of 17 at the end of the tax year. For 2020, the credit is worth $2,000 for each qualifying child, but certain income limits will lower this credit amount.

To qualify for the Child Tax Credit, the child must be a dependent with a specific relationship to the taxpayer who has lived in the taxpayer’s home for more than a half of the year. Legally adopted children and any child lawfully placed in a home in preparation for adoption are included among those considered to be in the required relationship status.

While adopting a child is a daunting process, dealing with tax issues arising as the natural consequence of that adoption can seem daunting as well. Having a basic understanding of some of the common tax scenarios is helpful for sorting out what prospective adoptive parents need to do or what they need to have clarified by a tax professional. Substantial tax benefits available with the federal adoption tax credit or the child tax credit make learning something about how taxes may impact an adoption a worthwhile endeavor.