Tax Tips: 10 Things to Know About the Adoption Tax Credit

In a previous article I explained one of the most important personal tax credits offered to U.S. taxpayers, the adoption tax credit.

If you’ve recently adopted a child, you may be eligible for an healthy tax savings, courtesy of the federal government. That’s because Uncle Sam recognizes that adopting a child serves the public good.

The feds also know that adopting a young person – not to mention raising him or her – is very expensive; thus the adoption tax credit.

One drawback to claiming the adoption tax credit, however, is that you are far more likely to be audited by the IRS. But as long as you only claim legitimate expenses, you should move confidently in seeking every tax break to which you are entitled.

So if you adopted a child in 2012 or are considering adoption in 2013, here are 10 things the IRS wants you to know about adoption tax benefits.

1. There is a cap on total benefits.

According to the IRS, the maximum adoption tax credit and exclusion for 2012 is $12,650 per eligible child.

2. Age limits apply.

To qualify for this tax break, the child you adopt must generally be under 18 years old. There is, however, an exception to this rule: it’s when you adopt children who are physically or mentally unable to care for themselves.

3. You can’t get a tax refund with this credit – which is a big change in 2012.

Back in 2010 and 2011, thanks to The Patient Protection and Affordable Care Act, the adoption tax credit was fully refundable. Unfortunately, that is no longer the case.

For 2012, the adoption tax credit is nonrefundable. In effect, this means that the adoption tax credit can reduce your taxes to zero, but it can’t net you a tax refund – like other refundable tax credits, such as the Earned Income Tax Credit.

4. A carry-forward provision exists.

Even though the adoption credit won’t let you snag a tax refund, if your credit exceeds your tax, you may be able to carry-forward the unused credit.

So if you have an unused credit amount in 2012, you can use it to reduce your taxes for 2013. In fact, you can carryover an unused adoption tax credit for up to five years or until you fully use the credit, whichever comes first.

5. You have to use the mail.

You must use Form 8839, Qualified Adoption Expenses, to claim the adoption credit and exclusion. But you can’t file this form electronically; the IRS only accepts in via the mail.

This is kind of a pain, especially since the IRS encourages everyone to e-file. So the solution, if you’re claiming the adoption tax credit, is to fill out and complete your tax return, including Form 8839, electronically. Then you can print and mail your entire paper federal tax return to the IRS.

6. Your expenses must pass the “reasonable and necessary” test.

The IRS says that any adoption expenses you claim must directly relate to the legal adoption of the child and they must be “reasonable and necessary.” Some expenses that qualify are: adoption fees, attorney fees, court costs, and travel costs.

7. A special rule is in effect for American special needs children.

Under IRS guidelines, a special rule applies if you adopted an eligible U.S. child with special needs and the adoption is final. The gist of the rule is that you may be able to take the tax credit even if you did not pay any qualified adoption expenses. Check out the Instructions for IRS Form 8839 for more information about this rule.

8. You should check your employer’s adoption benefits policy.

If your employer has a written qualified adoption assistance program, you may be eligible to exclude some of your income from tax. Again, refer to the instructions for Form 8839 for more details on this aspect of the adoption tax credit.

9. You may qualify for two benefits – instead of just one.

IRS rules stipulate that you may be able to claim both the tax credit and the tax exclusion when you adopt a child, depending on your total adoption costs. However, you can’t claim both a credit and exclusion for the exact same expenses. This rule prevents you from unfairly “double dipping” when claiming certain tax benefits.

10. Income limitations apply.

The credit and exclusion are subject to income limitations, which could reduce or eliminate the amount you can claim. For most individuals and families, this won’t be a problem as the IRS guidelines are quite generous and tied to your modified adjusted gross income.

For example, if your modified adjusted gross income in 2012 was $189,710 or less, then the income limit will not affect your adoption tax credit or exclusion at all.

If your modified adjusted gross income in 2012 was between $189,711 and $229,709, the IRS income limit will reduce your adoption tax credit or exclusion.

Also, if your modified adjusted gross income in 2012 was $229,710 or more, the IRS income limit will completely eliminate your credit or exclusion.

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