Tax Law Changes Encourage Adoptions

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It is vital to determine qualifying adoption expenses

3. What are “Qualifying Adoption Expenses”?

Qualifying adoption expenses are reasonable and necessary adoption fees, court costs, attorney fees, traveling expenses (including amounts spent for meals and lodging) while away from home, and other expenses directly related to, and whose principal purpose is for, the legal adoption of an “eligible child.” An eligible child is under 18 years old or physically or mentally incapable of caring for himself or herself. For a foreign adoptee to be considered an eligible child, he or she must be under 18 years old.

It is important to note that as with other credits and exclusions in the tax law, the IRS will be looking to prevent taxpayers from abusing the ATC and exclusion by fraudulently claiming expenses that did not exist or by “padding” actual expenses. Thus, when the tax law provides that qualifying adoption expenses must be “reasonable and necessary,” and “directly related to, and whose principal purpose is for” a legal adoption, these are legal standards by which the IRS will review your tax return and determine whether your claim for the ATC or exclusion is valid. For example, the expense for chartering a private jet to take you overseas to meet your adopted child probably is not a reasonable expense for which you could claim the credit or exclusion. In addition, such a claim would likely serve as a “red flag” to the IRS and may prompt an audit of your tax return. Thus, as you incur adoption expenses, you should keep in mind the legal standard when determining what is a qualifying adoption expense.

Non-qualifying expenses include, among other things, expenses that violate state or federal law, expenses for the adoption of your spouse’s child, expenses paid using funds received from any federal, state, or local program, expenses allowed as a credit or deduction under any other federal income tax rule, or expenses paid or reimbursed by your employer (except for amounts paid or reimbursed under an adoption assistance program).

4. When can you take the ATC and/or Exclusion?

There are important differences regarding if and when you could claim the ATC or exclusion depending on whether the eligible child is a U.S. citizen or resident. If the eligible child is a U.S. citizen or resident, you can claim the credit or exclusion even if the adoption is never finalized. However, if you are adopting a foreign child, you cannot take the adoption credit or exclusion unless and until the adoption becomes final. You may claim the credit and/or exclusion as shown in the following tables.


Adoption of a Child who is a U.S. Citizen or Resident
If you pay qualifying expenses in
Then take the credit in
Any year before the year the adoption becomes final
The year after the year of the payment
The year the adoption becomes final
The year the adoption becomes final
Any year after the year the adoption becomes final
The year of the payment

If your employer pays for qualifying expenses under an adoption assistance program in

Then take the exclusion in

Any year
The year of the payment

 

Adoption of a Child who is not a U.S. Citizen or Resident
If you pay qualifying expenses in
Then take the credit in
Any year before the year the adoption becomes final
The year the adoption becomes final

The year the adoption becomes final

The year the adoption becomes final
Any year after the year the adoption becomes final
The year of the payment
If your employer pays for qualifying expenses under an adoption assistance program in
Then take the exclusion in
Any year before the year the adoption becomes final
The year the adoption becomes final
The year the adoption becomes final
The year the adoption becomes final
Any year after the year the adoption becomes final
The year of the payment

 

If your employer makes adoption assistance payments in a year before the adoption of a foreign child becomes final, you must make an adjustment on your tax return for the earlier year to include the payments in your income. Then, on your return for the year the adoption becomes final, you may make an adjustment to take the exclusion.

If your tax liability is less than your available credit, you may carry forward the amount of credit left over, until it is used, for a period of 5 years. For example, assume that your tax liability is $4,000 but you have $7,000 in adoption expenses. You can claim a $4,000 credit for the tax year and carry forward the remaining $3,000 of credit to offset tax liability for the next 5 tax years, if necessary.

You can also apply the credit to offset any taxes owed under the alternative minimum tax.

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3. What are "Qualifying Adoption Expenses"?

It is vital to determine qualifying adoption expensesQualifying adoption expenses are reasonable and necessary adoption fees, court costs, attorney fees, traveling expenses (including amounts spent for meals and lodging) while away from home, and other expenses directly related to, and whose principal purpose is for, the legal adoption of an "eligible child." An eligible child is under 18 years old or physically or mentally incapable of caring for himself or herself. For a foreign adoptee to be considered an eligible child, he or she must be under 18 years old.

It is important to note that as with other credits and exclusions in the tax law, the IRS will be looking to prevent taxpayers from abusing the ATC and exclusion by fraudulently claiming expenses that did not exist or by "padding" actual expenses. Thus, when the tax law provides that qualifying adoption expenses must be "reasonable and necessary," and "directly related to, and whose principal purpose is for" a legal adoption, these are legal standards by which the IRS will review your tax return and determine whether your claim for the ATC or exclusion is valid. For example, the expense for chartering a private jet to take you overseas to meet your adopted child probably is not a reasonable expense for which you could claim the credit or exclusion. In addition, such a claim would likely serve as a "red flag" to the IRS and may prompt an audit of your tax return. Thus, as you incur adoption expenses, you should keep in mind the legal standard when determining what is a qualifying adoption expense.

Non-qualifying expenses include, among other things, expenses that violate state or federal law, expenses for the adoption of your spouse's child, expenses paid using funds received from any federal, state, or local program, expenses allowed as a credit or deduction under any other federal income tax rule, or expenses paid or reimbursed by your employer (except for amounts paid or reimbursed under an adoption assistance program).

4. When can you take the ATC and/or Exclusion?

There are important differences regarding if and when you could claim the ATC or exclusion depending on whether the eligible child is a U.S. citizen or resident. If the eligible child is a U.S. citizen or resident, you can claim the credit or exclusion even if the adoption is never finalized. However, if you are adopting a foreign child, you cannot take the adoption credit or exclusion unless and until the adoption becomes final. You may claim the credit and/or exclusion as shown in the following tables.


Adoption of a Child who is a U.S. Citizen or Resident

If you pay qualifying expenses in
Then take the credit in
Any year before the year the adoption becomes final
The year after the year of the payment
The year the adoption becomes final
The year the adoption becomes final
Any year after the year the adoption becomes final
The year of the payment

 

If your employer pays for qualifying expenses under an adoption assistance program in

Then take the exclusion in

Any year
The year of the payment

 

Adoption of a Child who is not a U.S. Citizen or Resident

If you pay qualifying expenses in
Then take the credit in
Any year before the year the adoption becomes final
The year the adoption becomes final

The year the adoption becomes final

The year the adoption becomes final
Any year after the year the adoption becomes final
The year of the payment

 

If your employer pays for qualifying expenses under an adoption assistance program in
Then take the exclusion in
Any year before the year the adoption becomes final
The year the adoption becomes final
The year the adoption becomes final
The year the adoption becomes final
Any year after the year the adoption becomes final
The year of the payment

 

If your employer makes adoption assistance payments in a year before the adoption of a foreign child becomes final, you must make an adjustment on your tax return for the earlier year to include the payments in your income. Then, on your return for the year the adoption becomes final, you may make an adjustment to take the exclusion.

If your tax liability is less than your available credit, you may carry forward the amount of credit left over, until it is used, for a period of 5 years. For example, assume that your tax liability is $4,000 but you have $7,000 in adoption expenses. You can claim a $4,000 credit for the tax year and carry forward the remaining $3,000 of credit to offset tax liability for the next 5 tax years, if necessary.

You can also apply the credit to offset any taxes owed under the alternative minimum tax.

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