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| The Basics | $10,000 adoption credit has many strings
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The federal tax credit that helps defray much of the cost of adopting a child is now twice as generous. Here's what you need to do to qualify.
By Liz Pulliam Weston
When it comes to adoption, many people face a long, exhausting experience full of delays and bureaucratic hoops. And thats just when theyre trying to take the so-called adoption tax credit.
The good news is that the credit has been made more generous. The bad news is that its even more complicated than before. So get out your notebook, grab a cup of coffee and settle in for a tutorial that hopefully will make a little more sense of the process.
Here are the basics:
For tax purposes, there are three types of adoptions: domestic, foreign and special needs. Special-needs adoptions involve children who are U.S. citizens with handicaps or who live in foster homes, among other situations.
The adoption tax credit is now $10,390 for all three types of adoption. Previously, the limit had been $5,000 for domestic and foreign adoptions and $6,000 for special-needs adoptions. The credit is linked to inflation.
Failed adoption attempts count, as long as its a domestic or special needs adoption. The credit is cumulative, however: if more than one adoption attempt doesnt succeed, or if you succeed after failing one or more times, your credit for all the attempts is limited to $10,390. And people involved in a foreign adoption can take the credit only when the adoption becomes final.
More people can take the adoption credit now that Congress has raised the income limit. The tax break used to phase out starting at adjusted gross incomes of $75,000, married or single. Now the phase-out begins at $155,860 -- again, married or single.
The tax break is limited to how much you actually spent -- unless you adopted a special-needs child. People adopting special-needs kids can take up to the full credit, even if they dont spend that much during the adoption process. In the other two types of adoptions, the tax break is limited to the amount spent on qualifying expenses: adoption fees, attorneys fees, court costs and travel time, among others.
Not all expenses count. You cant take the credit for expenses that violate state or federal laws, like buying a baby on the black market. Costs incurred in surrogate parenting arrangements or adoptions of a spouses child also dont qualify. Nor do expenses that are reimbursed by others, such as an employer or a government subsidy program.
The credit is nonrefundable. That means the credit can only be used to reduce your tax liability to zero. You can't get a refund for more than the amount of your withholdings. The unused credit can, however, carry over into future years.
Timing is everything
Now that youve absorbed all that, you need to know that there are unique timing issues involved in taking the adoption tax credit, says Mark Luscombe, principal analyst for CCH Inc.
With most other tax breaks, you take the credit or deduction in the year you qualify. With the adoption credit, Luscombe says, you may be required to take the credit in the year after you spend the money or start the adoption process.
Heres how it works. If an adoption hasnt been made final by the end of the tax year in which you spent money on a domestic adoption attempt, or in which you started a special-needs adoption, then you would wait until the next year to start taking the credit.
If, on the other hand, the adoption is made final in the year in which you spent money on a domestic adoption or started a special-needs adoption, then you can take the credit for the same tax year.
With foreign adoptions, the process must be final before you can take any tax credit. Youd take the credit in the same year the adoption became final.
Remember, too, that the $10,390 limit is for each adoption attempt. That means if you spend $6,000 in one year and $6,000 the next trying to adopt the same child, you can take the credit for only $10,390 of the total $12,000 in expenses.
If your credit is limited because your tax bill isnt big enough, you have up to five years to use the remainder. Say you spent $10,000 on a domestic adoption but your net tax liability for that year was just $7,000. You can apply $3,000 of the unused credit to your next year's taxes.
You can claim the adoption credit using Parts I and II of IRS Form 8839.
Liz Pulliam Weston's column appears every Monday and Thursday, exclusively on MSN Money.
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