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Someone on the 'adoption tax credit board from the 'adoptive parents board, explained it very, very well awhile back. She worked with taxes and by golly, she was able to explain it well enough that I understood it loud and clear for the very first time!
In fact, I'm gonna see if I can paste it on here: The thread is called, "Receive a refund each year'. It has several posts to it, but I found that the ones posted by Chieffan9 make a lot of sense.
Below is one of the posts:
Originally Posted By chieffan9
Kathy,
What you SHOULD do is really up to you. The "ultimate" way to go about your taxes is to try to work it out to where you have a zero refund, but don't have to pay anything on April 15, either. This would mean that you paid the EXACT right amount of taxes throughout the year, you don't owe the government anything, but you also didn't give the government an interest-free loan for a whole year, and you got back the maximum money from each paycheck. However, this is virtually impossible to do.
Many people set up their taxes as a sort of built-in savings tool. They have their employer take out too much money during the year so that they make sure to get a nice refund. This is fine, as long as you understand that if your refund would have been smaller, your paycheck each week or month would have been bigger and you could have taken that extra money and invested it and made some money off of it. As it is, the government gets to use your money for free until they give it back to you via a refund check.
In this particular situation, if you leave everything alone and continue to have your employer take out the same as they always have, then not only will you get your normal refund back, but you will ALSO get an amount equal to your total Federal Income Tax bill back as well. In other words, your refund check will be HUGE. Part of it will be your normal refund, the other part will be a sort of repayment of your adoption expenses.
However, you CAN have your employer take out less, like you said. However, you still won't OWE anything at the end of the year, as long as your adoption takes place in that year. That's kind of the beauty of this particular tax credit. For most people, every dime that they would normally have paid to the government in Federal Income Taxes, is instead used for the adoption. Let me give you a quick example.
Example A (normal year): Let's say that your income is $50,000 and after all deductions, etc., you file your return and you should have paid $5,000 in Federal Income Taxes during the year. However, your employer took out $7,000 from your paychecks during the year and sent it to the government. They paid too much. This means that the government will send you a refund check for $2,000. There is your normal refund.
Example B (adoption year): Same situation, except this year you adopted a child and had expenses of at least $5,000. This time, instead of receiving a check for $2,000, you will receive a check for $7,000. It's the $2,000 that you would normally get, PLUS the government is giving you back the $5,000 that you would normally have paid them so you can use that money instead on adoption expenses.
If you have good willpower and are able to set aside the extra money from your paycheck every month and use it on adoption expenses, etc., then by all means have your employer hold out the least amount possible from your paychecks every month. However, if you are like me, and have a hard time making sure that money goes where it's supposed to, then I would leave everything alone, get your BIG check in April of next year, use part of it just like you would your normal refund check, and put the rest (the $5,000 extra in my example) to pay off that loan you took out to finance the adoption, or build your savings back up, etc. Use it against those adoption expenses you incurred.
There are more posts, and the thread is pretty thorough. It surely helped me!
Sincerely,
Linny
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