The Internal Revenue Service encourages the placement of children into qualified homes by providing a pretty significant tax credit to families who adopt. It’s not a per-adoption tax break, either – the adoption tax credit is per child. It doubles if you adopt two children together. It’s not limited to domestic or agency adoptions. International adoptions, foreign adoptions and the legal adoption of an eligible child from foster care can qualify as well.
The credit can remove a good deal of the financial difficulty involved with giving children homes, but the IRS almost always imposes a lot of rules whenever it offers tax benefits. The adoption tax credit is no exception.
How Much Is the Adoption Credit?
The most adoptive parents could qualify for in the 2019 tax year was $14,080 per child. This increases to $14,300 in 2020 because the credit is indexed for inflation. It changes periodically to align with the current economy.
Unfortunately, this doesn’t mean that all adoptive families will receive this much of a tax credit. The figure is basically a starting point. You can only claim all of it if you spend that much on qualified adoption expenses and don't have to subtract from the amount according to other rules. Otherwise, the credit is limited to how much you actually spend in most cases.
If you spend $15,000 or more – and this isn’t uncommon – you’re still limited to that $14,080 or $14,300 figure, depending on the year in which you adopt. And you generally can’t include any expenses that were reimbursed by your employer or by the government.
Of course, the child you adopt must be eligible for the tax credit. An eligible child is one who is either under age 18, or they're disabled to the point where they cannot mentally or physically care for themselves. Stepparent adoptions of a spouse’s child don’t qualify.
Qualified Adoption Expenses
Your expenses must also qualify. The IRS says that qualified adoption expenses must be “reasonable and necessary.” This includes attorneys' fees and court costs, traveling expenses and basically anything you must spend if you’re going to adopt the child because the adoption wouldn’t go through otherwise.
These expenses can be incurred before you actually identify the child you want to bring into your home, such as adoption fees you might spend on a home study to begin the adoption process and to ensure that you qualify to adopt in the first place. You can still claim the expenses toward the tax credit if something goes wrong so you don’t actually end up finalizing the adoption.
Income Limitations and Phaseouts
Those are the easy rules. The full amount of your adoption tax credit can be whittled down in a few ways from here.
First, this is one of those tax credits that’s subject to income limitations and phaseouts. The more you earn, the less of a credit you’ll qualify for, and top earners can’t claim the adoption tax credit at all. Fortunately, you’d have to have a pretty healthy income for these thresholds to affect you.
As of 2019, your adoption tax credit won’t be affected unless you earn at least $211,160..) This increases to $214,520 in the 2020 tax year. The credit will then begin reducing incrementally until you reach an income of $251,600 in 2019, or $254,520 in 2020. At this point, you’re phased out so you can’t claim the credit at all.
These thresholds are your modified adjusted gross income, not necessarily your gross income or everything you earn before you take any above-the-line tax deductions. For most taxpayers, their MAGI is the same as their adjusted gross income, which appears on line 8b of the 2019 Form 1040 income tax return, or on line 11 of the 2020 Form 1040.
The Dollar Limitation
After you determine how much of a credit you’re eligible for based on your income – and it will most likely be the cap amount if you’re an average earner – the tax code begins scissoring away at your qualifying expenses. The first step in this process is referred to as the dollar limitation.
Remember, these are per-child expenses with a cap of $14,300 in the 2020 tax year, and adoptions can sometimes take years. You don’t necessarily have to wait until the adoption is final to begin claiming the tax credit for what you spend, although this isn’t the case with all adoptions. You can claim the credit in subsequent years until the adoption is finalized, as long as you continue to have qualifying expenses.
But the $14,300 cap is for the entire adoption – it’s not a yearly limit. Maybe you spent $2,000 in year one, and $14,300 or more in year two. You must therefore subtract $2,000 from the $14,300 in year two, leaving you with an $12,300 adoption tax credit in that second year.
Special Needs Children
Normally, you would also have to deduct from your adoption credit any financial adoption assistance you receive from a government entity, but this rule doesn’t apply to special needs children. “Special needs” doesn’t imply the usual meaning of the term in this case. It means a child who would be unadoptable if the state didn’t offer financial subsidies to the parents when it relates to the adoption credit, so the state or an agency does just that to ensure that these children find homes.
In adoption language, a "special needs" child might additionally be disabled, but the disability alone won’t qualify him as being special needs for purposes of the adoption tax credit.
The special needs child must also be a citizen or resident of the United States or any of its possessions at the time the adoption begins. Foreign children don’t qualify for this loophole. The state must also make the determination that they cannot be returned to their parent or guardian for some reason.
Special Needs Adoptions Have a Different Rule
You can usually claim the entire adoption credit up to the maximum cap in the year the adoption is finalized when you adopt a special needs child, even if you had zero expenses because the state or agency reimbursed you entirely. You don’t have to subtract these payments from the amount of your credit.
But, of course, you might still be subject to the other rules that can reduce the amount of the credit.
Tax Credit vs. Tax Exclusion
As for financial adoption assistance that might be provided by your employer, you must subtract these adoption benefits from your tax credit as well, at least if you’ve already received a tax break for this money.
The Internal Revenue Code allows you to exclude adoption assistance from your taxable income up to the amount of that year’s maximum adoption credit.
In other words, if your employer helps out by contributing $15,000 to your costs in 2020, you can exclude $14,300 of that gift from your taxable income, but you’d have to pay taxes on the $700 balance of the gift.
The idea is that you can’t also claim a tax credit for spending the money if you’re not being taxed on it in the first place. You can potentially make use of both the credit and the exclusion in the same year, but you can’t use the same expenses for each. You can pay for Expense A through the exclusion, but you can’t then also apply Expense A to your adoption tax credit.
You must use up the exclusion first, effectively applying it to all your adoption expenses until it’s tapped out. Then you can begin keeping a tally of the expenses you can apply to the credit. The dollar limitation rule applies to the exclusion as well.
Claiming the Credit
Actually claiming the adoption tax credit is subject to a few tricky rules, most of them pertaining to timing. When you can claim the credit depends on when you paid the expenses, when the adoption was finalized – if it was – and whether it was a domestic or international adoption.
- If you adopt domestically: You can claim your expenses after the year in which you pay them, even if the adoption isn’t final yet. In fact, you must do so.
- If you adopt an international child: You can’t apply your expenses and claim the adoption credit until the adoption is finalized.
- If you adopt a special needs child: You should also claim the credit in the year the adoption is finalized if you adopt a special needs child.
Submit Form 8839 With Your Tax Return
You must submit IRS Form 8839 with your federal tax return in any year you’re claiming the tax credit. You don’t generally have to attach your adoption paperwork, although this was the case in years past. Be sure to keep your paperwork within easy reach, however, in case your expenses are ever called into question.
You do have to submit proof of your child’s special needs status if you’re claiming expenses for adopting a special needs child. This can be a signed subsidy agreement from the state, or any state- or county-issued certificate confirming the child’s special needs. It could also be a certificate stating that the child was approved to receive adoption assistance.
The Tax Credit Isn’t Refundable, But…
This isn’t a refundable credit, so the most it can do is eliminate any tax debt you might owe when you complete your tax return for that year. If there’s any credit left over after it reduces your tax owed to zero, the IRS gets to keep the balance, but only for a little while.
You can carry your unused adoption tax credit forward from one tax year to the next if you don't use it up eliminating your tax in year one. Maybe you owed the IRS $1,000, and you qualified for the entire $14,300 adoption tax credit that year. You’d have $13,300 left over after the credit eliminates your tax debt. You can then apply that $13,300 to any tax liability you might owe the IRS for up to five additional years. You can continue to use it after you claim it to erase your tax debts for a total of six years.
And only rarely do tax laws remain unchanged forever. The adoption tax credit was actually refundable in tax years 2010 and 2011 under the Patient Protection and Affordable Care Act, so it’s always within the realm of possibility that Congress might take steps to make it refundable again at some point in the future.
The Child Tax Credit vs. the Adoption Tax Credit
The child tax credit takes precedence over the adoption tax credit if you happen to claim this one as well in the same tax year. That’s because a portion of the child tax credit is refundable – after it eliminates your tax bill, the IRS will send you a check for any unused portion up to $1,400 as of 2020.
The IRS doesn’t want to send you that check, so it will first use your child tax credit refund toward what you owe the IRS before it starts applying your adoption tax credit for the same purpose, effectively using the child tax credit up so it doesn’t have to send you money. But at least you can still use your adoption credit for five more years.
Beverly Bird has been writing professionally for over 30 years. She is also a paralegal, specializing in areas of personal finance, bankruptcy and estate law. She writes as the tax expert for The Balance.