If you’re adopting a child, or plan to do so in the future, you know that the process can be expensive. Although expenses are minimal for adoptions through the foster system, the cost of adopting a child through a private agency averages around $43,000 in the United States. Fortunately, there are tax benefits that can help offset some of the costs.
Specifically, there are two tax benefits for adoption: a tax credit for qualified adoption expenses and an income exclusion for employer-provided adoption assistance. Both are subject to a maximum amount, and both are phased out for higher-income taxpayers. Here are the details.
Qualified adoption expenses for the credit and exclusion include:
- Reasonable and necessary adoption fees,
- Attorney fees and court costs,
- Travel expenses (including meals and lodging), and
- Other expenses directly related to, and for the principal purpose of, legally adopting an eligible child.
An eligible child is either 1) under 18 or 2) physically or mentally incapable of self-care. However, qualified adoption expenses don’t include expenses related to adopting your spouse’s child.
Income limits and maximum benefits
Both the credit and exclusion are phased out once your modified adjusted gross income (MAGI) reaches certain levels. (MAGI is adjusted gross income with certain additions and subtractions.) For 2023, adoption tax benefits begin to phase out at MAGI of $239,230 and are eliminated once MAGI reaches $279,230.
The dollar limit on adoption benefits ($15,950 per child in 2023) applies separately to the credit and the exclusion. That means you can claim both benefits in connection with the same adoption, but you can’t claim them for the same expenses. IRS rules require you to claim any allowable income exclusion before claiming any allowable credit.
Suppose, for example, that in 2023, you pay $15,950 in qualified adoption expenses in connection with an adoption that’s finalized the same year. In addition, your employer reimburses you for $5,000 of these expenses. Assuming your MAGI is less than $239,230, you can exclude the $5,000 reimbursement from your gross income. This reduces your expenses for purposes of the credit by $5,000, so your credit is limited to $10,950. If, on the other hand, your qualified adoption expenses are $20,950, you’re entitled to exclude $5,000 from income and claim the full $15,950 credit.
The credit isn’t refundable. But it can be carried forward for up to five years.
Timing of the credit
Special rules apply to the timing of the credit. They vary depending on when you pay the expenses, whether your adoption is domestic or foreign, and when the adoption is finalized (if at all).
For a domestic adoption (meaning adoption of a child who’s a U.S. citizen or resident when the adoption effort begins), qualified expenses paid before the year the adoption becomes final are allowable as a credit (subject to the dollar limit) for the year following the year they’re paid (even if the adoption is never finalized). For a foreign adoption, qualified expenses are allowable as a credit (subject to the dollar limit) for the year in which it becomes final (whether they’re paid in that year or earlier).
Once an adoption becomes final (whether it’s domestic or foreign), qualified expenses paid during or after that year are allowable as a credit (subject to the dollar limit) for the year of payment.
Be aware that the credit limit for a particular year must be reduced for expenses paid and claimed as credits in previous years in connection with the same adoption effort. For example, if you claimed a $5,000 credit in 2022 (for expenses paid in 2021) in connection with a domestic adoption and pay another $15,950 in qualified expenses in 2023, when the adoption is finalized, your maximum credit in 2023 is $10,950 ($15,950 minus $5,000).
Also, in determining the dollar limit, qualified expenses paid and claimed as a credit in connection with an unsuccessful domestic adoption must be combined with expenses paid in connection with a subsequent domestic adoption attempt (successful or not).
Joint filing requirement for married couples
Although individuals can claim adoption tax benefits, married couples who wish to claim the credit or exclusion must file a joint return. However, there’s an exception for couples who are separated and meet certain other requirements.
Couples who filed as married filing separately in a year when qualified expenses were paid may need to amend those returns to change their filing status to married filing jointly to claim the credit or exclusion. Keep in mind, though, that changing your filing status may affect your eligibility for other tax benefits.
Know the costs
If you’re contemplating adopting a child, familiarize yourself with the various expenses involved. Consult your tax professional to help calculate the potential tax benefits for an accurate picture of the total cost.
Special rules for adopting a child with special needs
If you adopt a child with special needs, you may be eligible for tax benefits, regardless of whether you or your employer actually pay any qualified adoption expenses. Note, however, that “special needs” has a specific meaning. For purposes of the credit and exclusion, a child has special needs if:
- He or she is a U.S. citizen or resident when adoption efforts begin,
- A state determines that the child can’t or shouldn’t be returned to his or her parent’s home, and
- The state determines that the child probably won’t be adoptable unless assistance is provided to the adoptive family.
If you adopt a child who meets this definition, you may be eligible for the maximum credit, even if you pay no qualified adoption expenses. You may also be eligible for the maximum exclusion, regardless of whether your employer pays any expenses, if your employer has a written qualified adoption assistance program.