The deal struck at the beginning of they year to avert the fiscal cliff restored the adoption tax credit and made it permanent, which is good news for parents.
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The adoption credit was created in 1997 and through 2009 the credit was nonrefundable, meaning that if you couldn’t apply it to an existing current tax liability you wouldn’t get it, however, you were able to carry it forward to subsequent tax years
For 2010 and 2011 the credit was refundable. For 2012 and onward the credit reverts to being nonrefundable, and the maximum credit for 2012 is $12,650 per child. If you are taking this credit be careful because you may not enjoy any of the credit if your 2012 modified adjusted gross income is beyond the exclusion levels of $229,710. There is a phase out after your income reaches $189,710. In order to claim the credit, you must file as single, married filing joint, head of household or qualifying widow(er) with a dependent child. You cannot claim the credit if your filing status is married filing separately.
The costs you may deduct fall under the ordinary and necessary expense categories and include: attorney fees, travel and meals expenses, adoption fees, court costs and re-adoption fees if dealing with a foreign adoption. You cannot claim expenses for any transaction for which you were reimbursed by any state, federal or local agency. Nor can you claim any expenses that are in violation of any federal or state law (like bribes), or for expenses paid for a surrogate arrangement, or for the adoption of your spouse’s child, or that can be claimed elsewhere on your tax return.
The adoption credit has a tricky set up: An exclusion is available as well as the tax credit itself. The exclusion allows you to deduct expenses from your gross income thus reducing the amount of your taxable income, whereas the credit reduces your tax liability. Both are subject to the income and dollar limitations.
Be sure to thoroughly read the IRS instructions or consult with a tax professional to determine how to calculate the credit and the exclusion and how to treat expenses paid in prior years.
If you adopt a special needs child, you may take the full credit without incurring the full amount of the expenses. This is an additional tax benefit for adopting such a child. Here again definitions come into play. You and the IRS may have a different definition. Naturally, it’s the IRS’ definition that sticks and that is that the state must certify that the child has special needs and the child must be a U.S. citizen. Make sure you have documentation to prove this claim in the event of an audit.
According to the IRS, for 2013 the credit will be $13,360 per child.
Attach a copy of the adoption order or decree to your tax return or you may slow down the processing of your refund.
To take the credit, complete IRS Form 8839 and attach it to your tax return. Do not be surprised if you are audited – the IRS likes to check your math and confirm your expenses and the timing of those expenses. Be sure to keep all receipts and documentation to back up your claim.
Bonnie Lee is an Enrolled Agent admitted to practice and representing taxpayers in all fifty states at all levels within the Internal Revenue Service. She is the owner of Taxpertise in Sonoma, CA and the author of Entrepreneur Press book, “Taxpertise, The Complete Book of Dirty Little Secrets and Hidden Deductions for Small Business that the IRS Doesn't Want You to Know.” Follow Bonnie Lee on Twitter at BLTaxpertise and at Facebook.