Uncle Sam Can Help Pay Some Adoption Costs

Raising kids is expensive. And if you're trying to adopt, it can cost you even more.

But there is tax help available. Parents can claim a tax credit that covers some adoption expenses. For 2011 returns, the credit could be as much as $13,360.

And for the 2011 tax year, a provision in the health care reform act makes the adoption tax credit refundable. That means if you don't owe the Internal Revenue Service anything when you file, the credit will be returned to you as a refund.

To get that tax credit, however, you need to keep close track of the adoption process. The exact year you can claim your expenses depends on several factors, including when the expenses were paid, when the adoption was finalized, and even whether your new son or daughter is a U.S. citizen or resident.

Acceptable adoption documents

The final adoption decree.
A placement agreement from an authorized agency.
Court documents.
A state's determination for special-needs children.

You also must file a paper tax return. The IRS isn't accepting e-filed returns where the adoption tax credit is claimed, because the agency requires filers to attach documents supporting the adoption. You can still use computer software, including the IRS' Free File program, to prepare your tax return and adoption claim. You must print out the forms and mail them, and the adoption documentation, to the IRS.

Domestic vs. Foreign Adoptions

If the child you adopt is U.S.-born or a resident, there are IRS guidelines on when you can take the credit.

Court costs, adoption charges, attorney fees and travel expenses are some of the items covered by the credit.

The rules for a foreign adoption are slightly different. In these cases, any costs you incur cannot be taken until the year the adoption is final. Once your adoption of a foreign-born child is completed, any expenses you pay after that can be claimed the year they are paid. With domestic adoptions, you can claim your expenses even if the adoption never is completed.

The final adoption date -- and availability of the tax credit -- in cases involving children who were not born in the United States depends on when the foreign-born child receives an "immediate relative," or IR, visa from the Department of State. Since there are various types of IR visas, check out Internal Revenue Announcement 2005-45 for details that could affect your particular circumstances.

Special Rule for Special-Needs Cases

An adoption is considered a special-needs case when the child is a U.S. citizen or resident when the process begins and the state or District of Columbia has determined the youngster should not or cannot be returned to his or her family.

The governing jurisdiction also must rule that because of special factors, assistance is required to place the child with adoptive parents.

When to claim the tax credit for a child who is a U.S. citizen or resident

In these cases, the new parents are allowed to claim the maximum credit amount even if their actual expenses did not reach that amount. For example, your special-needs adoption process was finalized in 2011. It took two years, over which time you spent $10,000.

On your 2011 return, you can claim an adoption credit of $13,360 even though your actual expenses fell $3,360 short.

Accounting for Employer Assistance

In addition to the tax credit, adoptive parents who get financial help from their companies may be able to avoid paying tax on up to $13,360 of that employee benefit.

The income exclusion, meaning you won't owe tax on the employer-provided adoption benefits, will apply to the tax year your boss provides them. The amount should be shown in box 12 of your W-2 and noted with the letter code T.

You may claim this income exclusion along with the tax credit for the same adoption, basically doubling your adoption tax break.

The only limitation: You cannot use the exclusion amount and credit to write off the same expense. For example, if your company reimburses your adoption travel costs of $8,000, you cannot use these expenses as part of your credit filing. But all other eligible costs up to the full credit amount may be counted.

Other Credit Considerations

While you can adopt a U.S.- or foreign-born child, in most cases, the youngster must be younger than 18. The age limit is waived if the child is physically or mentally challenged.

You cannot count expenses related to surrogate parents or the adoption of your spouse's child in figuring your allowable credit.

Married couples generally must file a joint return to take the adoption credit or exclusion. If you file as married filing separately, the credit is available only if you meet special requirements.

The credit amount is per child, not per year. So if the adoption of your son or daughter takes four years and costs $17,000, you will be able to claim only $13,360 of your expenses during that whole time.

You can carry forward any unused credit amounts for the adoption for up to five years. Now that the adoption credit is refundable, adoption credit carryforwards from 2006 through 2010 also are refundable on your 2011 taxes.

If the adoption is not completed, you still can claim the credit for your expenses in the unsuccessful adoption attempt.

The credit begins phasing out if your modified adjusted gross income exceeds $185,210. You can't claim the credit at all if you make more than $225,210. The same limits apply to either single adoptive parents or the total income of married couples filing jointly.

Claim your adoption expenses, as well as any adoption-related benefits you received from your employer and can exclude from your income (also up to the $13,360 limit), on Form 8839, Qualified Adoption Expenses. Also, the adoption credit can no longer be claimed on the slightly shorter Form 1040A. You now must attach Form 8839 to the long Form 1040.