Research Topic
Determining the specifics of taxation in adoption assistance programs.
Primary Sources
26 USC 137: Adoption assistance programs [The United States Code]
Parameters for Deductibility
- Qualified adoption of a child and related expenses: adoption fees, court costs and attorney’s fees, travel expenses, and related expenses (Topic No. 607…, 2023).
- Qualified adoption exclusion does not exceed $10,000 if they are provided under an adoption assistance program with special needs regardless of expenses (26 USC 137…, 2021).
- The maximum amount of the tax credit may not exceed $14,890 (Topic No, 607…, 2023).
- The income limitation is based on amended and modified gross income (MAGI) must be between $223,410 and $263,410.
An Example Scenario of Applying AGI Adjustment
Suppose partners of either sex want to adopt a child to whom they are not related. The procedure would take place over a three-year period and would include expenses related to assessing the suitability of the prospective parents, assessing living arrangements, travel, and other expenses. All expenses would fall under the criteria of qualified adoption expenses because they are directly related to the authorization of the adoption and the adoption process itself. Adoption expenses have been set as follows: 2020 – $3,000, 2021 – $3,500, and 2022 – $8,000 (the year of final adoption).
The partners filed tax credit returns in 2020 and 2021 for amounts corresponding to qualified adoption expenses. In 2022, the return was filed on time, that is, the same year after the expenses were paid. In 2022, the partners claimed an $8,000 tax credit. Under the law, this amount falls within the allowable tax credit for the year and can be deducted from gross income.
The allowable adoption tax credit is $14,890 – $3,000 (for 2020) – $3,500 (for 2021) = $8,490. Since the amount claimed is less than the “balance,” clients qualify and can receive the full amount of qualified expenses in 2022.
An Example of Not Being Able to Apply AGI
Special rules for applying the tax credit apply to adoptions within or outside the United States. If clients adopt a child with a passport from another state that is not domiciled in the U.S., the tax credit is complicated by timing. Let’s say clients conducted a two-step adoption: in 2021 and 2022, they spent a combined $13,000 on the adoption. The final adoption occurred in April 2022, and at the end of 2023, the clients claimed a tax credit of $13,000 for 2022.
First, the tax credit petition was filed one year after the year of final adoption. For children outside of U.S. citizenship, the tax credit should be limited to the same year. Second, the clients did not incur $13,000 in spending in 2022. This was their cumulative spending, and the exclusions and credit apply only as part of the annual return. In this case, their return would not be accepted, and the exemptions would not apply.
Tax Planning Implications
Tax planning allows clients to manage their taxes because they have an understanding of their tax credit and exclusion options. There are several important aspects to consider when adopting.
First, clients should keep a record of spending that will qualify and provide a rationale for doing so. Second, the timing of filing the form must be incorporated into income planning for timely offset/exclusion because otherwise, the taxpayer will not be able to utilize this right even if it meets all the criteria. Third, the taxpayer must consider the amount of spending and reimbursable expenses by his or her employer. Consequently, in tax planning, clients additionally consider the categories of qualified income, the timing of filing for the offset/exclusion, and the availability of employer reimbursement.
References
26 USC 137: Adoption assistance programs. The United States Code (USC): Title 26 – Internal revenue code. US Code. Web.
Topic No. 607, Adoption credit and adoption assistance programs. (2023). Internal Revenue Service. Web.