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Just a positive story among all the 2011 refund angst:
Our tax return for 2010 was audited this week, and one of the areas of concentration was the adoption tax credit we took (which had been carried over from 2007 as a nonrefundable credit). We originally claimed two credits: a maximum credit for the successful adoption of our son in 2007, and a second credit - not the maximum amount - for the child we attempted to adopt in 2006 (his birthmother decided she wanted the baby to be placed with a local family rather than a family from 2000 miles away). In other words, we went against the IRS instructions and did not claim one credit, because our position is that the IRS interpretation is not consistent with either the law or the legislative history.
We provided copies of everything related to both adoptions. In the case of the failed adoption, we provided attorney retainer agreements and invoices, receipts for travel expenses, and canceled checks for everything. We also included a narrative of what happened and why the adoption fell through, and explained why we had no SSN or ATIN. For our son's adoption we provided copies of the adoption agency agreement, home study, attorney invoices, checks, etc.
The examiner asked about both adoptions and we told our story. She expressed her condolonces on the failed adoption but that was it. Her main concern was that all payments were made directly to attorneys and adoption agencies and not to the birthmother (since surrogacy fees aren't qualified adoption expenses).
I had been prepared to argue if she brought up the IRS interpretation regarding combining expenses from a failed adoption with a successful adoption and was even willing to go to appeals and tax court if necessary. But as it turned out, we didn't need to. We were told the audit was complete and there would be no changes to our tax return.:banana:
So the lessons learned from this experience:
1. Keep copies of all relevant documentation, receipts, credit card statements, and canceled checks supporting your qualified adoption expenses. We had to go back to the bank we used in 2006 to get copies of checks from a closed account. Fortunately, the bank was able to accommodate us (for a small fee).
2. Organize everything logically. Provide a detailed list of all the qualified expenses with a total that ties out to the amount you put on Form 8839. Make sure there is a receipt or canceled check supporting each individual amount.
3. Have a compelling story to tell and make sure your documentation supports your story. As an IRS auditor myself (but for large corporations, not individuals), I can tell you that in order to have your argument carry the day, it needs to be well organized, it has to properly apply the relevant law to the facts, and it has to have a good narrative.
4. Be ready to defend your position if questioned and know in advance at what point you want to cut your losses (or accept a partial settlement) if your case moves past the examination stage and into appeals or even to court. If your story is compelling enough, you may never get to that point (the IRS is actually quite risk-averse with cases that go to appeals).
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