Adopting a child is a significant life event that brings joy, but it also comes with various legal and financial considerations, including tax planning. Here’s everything you should know about tax planning considerations when adopting a child:
- Adoption Tax Credit:
The Adoption Tax Credit is a valuable tax benefit offered by the U.S. federal government to help offset qualified adoption expenses. For 2021, the maximum credit is $14,440 per eligible child. It’s a non-refundable credit, meaning it can reduce your tax liability to zero but won’t provide a refund beyond that. However, any unused credit can be carried forward to future years.
- Eligible Adoption Expenses:
To claim the Adoption Tax Credit, you must have qualifying adoption expenses. These include adoption agency fees, court costs, attorney fees, travel expenses (including meals and lodging), and other necessary adoption-related expenses. It’s essential to retain documentation and receipts to substantiate these expenses.
- Income Phase-Out:
The Adoption Tax Credit is subject to a phase-out based on your modified adjusted gross income (MAGI). If your MAGI exceeds a certain threshold, the credit gradually reduces until it is entirely phased out.
- Timing of Expenses:
You can claim the Adoption Tax Credit for qualified adoption expenses incurred before the adoption is finalized. In some cases, the adoption process may extend over multiple tax years, so it’s essential to keep track of expenses incurred during the entire process.
- Employer Adoption Benefits:
Check if your employer provides adoption assistance benefits. Some employers offer financial assistance or reimbursement for adoption-related expenses. These benefits may be tax-free up to a specific limit, reducing your taxable income.
- Filing Status and Dependency Exemption:
Once the adoption is finalized, you may be eligible to claim the child as a dependent, which could affect your filing status and the dependency exemption. Claiming the child as a dependent may lead to tax savings.
- Child Tax Credit:
After the adoption is finalized, you may qualify for the Child Tax Credit, which provides a credit of up to $2,000 per qualifying child under the age of 17 (as of 2021). This credit is subject to income phase-outs.
- Additional Tax Benefits:
Depending on your circumstances, you might be eligible for other tax benefits, such as the Earned Income Tax Credit (EITC) or the Child and Dependent Care Credit, which can further reduce your tax liability.
- Adoption of Special Needs Children:
For the adoption of children with special needs, you may qualify for the full Adoption Tax Credit, regardless of the actual expenses incurred. The IRS considers a child as having special needs if they are difficult to place for adoption and receive adoption assistance from a state or the District of Columbia.
- State Adoption Benefits:
Some states offer adoption-related tax credits, deductions, or other incentives. Research your state’s adoption-related tax benefits to maximize savings.
It’s essential to seek guidance from Matthew Jennings, JD, MBA, EA, RFC®, CEP®, CES™, aka Tax King Matt to navigate the complexities of tax planning for adoption. They can help you understand the specific rules and requirements, ensure you claim all eligible tax benefits, and make the most of your adoption-related tax planning.