Adoption Expense Credits - Part II

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Tax Center / Marriage & Family

Adoption Expense Credits, Part II
Qualifications for the Credit

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By Roy Lewis

In Part I of this series, we gave you a brief rundown of how the adoption credit actually works. But, we left you hangin' with an overview of the various qualifications -- children, expenses, etc. -- that must be met to claim the credit. So, let's get right to a more in-depth explanation of those qualifications.

Qualified Adoption Expenses

Your expenses must be "qualified" to be eligible for the adoption credit. The tax code defines qualified expenses as those that are reasonable and necessary, and that are directly related to the legal adoption of an eligible child. They include court costs, attorney fees, and even traveling expenses while away from home.

But, be aware that qualified expenses do not include the costs of any surrogate parenting arrangement or the costs of adopting your spouse's child. Expenses are not qualified if they are paid in violation of federal or state law. And, none of these expenses can be reimbursed under an employer adoption program or any other state or federal program.

Eligible Child

Not only must the expenses be qualified, but the child must also be "eligible." For this purpose, an eligible child must be either:
  1. Under age 18, or
  2. Physically or mentally incapable of caring for himself or herself
But again, remember that these standards only apply until December 31, 2001. After that date, only expenses paid for the adoption of a child with "special needs" will qualify for the credit. A child with special needs is defined as:
  1. A U.S. citizen or resident, and
  2. Who cannot or should not be returned to his/her parents' residence (as determined by the applicable state agency), and
  3. Who probably will not be adopted without assistance because of a specific factor or condition. Examples of those factors or conditions would include a child's ethnic background; age; membership in a minority or sibling group; medical condition; or physical, mental, or emotional handicap.

Marital Status

If you're married at the close of the tax year, you and your spouse must file a joint return to claim the credit. If one spouse dies during the year, and a joint return is allowed for the survivor and deceased spouse, the credit is allowed only if a joint return is filed.

A person legally separated under a decree of divorce or separate maintenance is not considered married. Certain individuals, while not legally divorced, may be considered unmarried for purposes of the credit. If you file a separate return for the year, maintain a household for a qualified individual for more than one-half of the year, and if your spouse is not a member of the household at any time during the last six months of the year, you will likely be considered unmarried for the purposes of the adoption credit.

But, don't think that only married people can take advantage of the adoption credit. Not at all. Single filers and Head-of-Household filers can also take advantage of the credit.

Income Limitations

Would any tax law be complete without deviations and limitations? Well, the adoption credit is no exception. The credit is phased out for taxpayers with modified Adjusted Gross Income (AGI) over $75,000. The phase-out is complete at modified AGI of $115,000. So, if you have income equal to or in excess of $115,000, you simply can't claim the credit. Seems simple enough, eh? Well, that's really only the start. Fasten your seat belts for the next paragraph.

The phase-out computations are performed by reducing the total credit by an amount bearing the same ratio to the allowable amount as the modified AGI exceeding $75,000 bears to $40,000. Huh? Let's try to look at this another way. (This'll give a charge to all of you math majors out there.) To compute your credit when you are in the phase-out range, try this formula:

Allowable credit = QAE - [QAE x ((MAGI - $75,000)/40,000)]

QAE = Qualified Adoption Expenses for the year, and
MAGI = Modified Adjusted Gross Income

Example: We'll continue the Jack and Jill example from Part I. Jack and Jill had allowable expenses of $3,000 this year. Let's assume that their modified AGI is $85,000. Their income is greater than $75,000, so we know right off the bat that their credit will be limited. But, we also see that their modified AGI is less than $115,000 so we know that they'll get at least a partial credit. The $3,000 credit is reduced by the ratio of $10,000 (their modified AGI of $85,000 minus $75,000) divided by $40,000, or 25%. Therefore, the credit is reduced by $750, (25% times $3,000), to $2,250. Better?

Modified AGI

To calculate modified AGI for the purposes of the adoption credit, disregard exclusions for foreign earned income and housing costs, income from specified U.S. possessions, and income from Puerto Rico. For most of you, your modified AGI will be exactly the same as your normal AGI. But, if you have foreign earned income, or exempted income from Puerto Rico, your computations are a bit more complex.

Reporting Compliance

A taxpayer claiming the adoption credit must file IRS Form 8839 (the instructions for Form 8839 are available online at the IRS website) with either Form 1040 or Form 1040A. Another filing requirement is that you must identify all eligible children on your return including, if known, the name, age, and taxpayer identification number (TIN) of each eligible child.

Identification Numbers

Many people find it difficult to obtain a child's Social Security number while in the midst of an adoption. The IRS understands this and has provided a procedure to obtain a temporary taxpayer identification number to comply with the adoption credit reporting requirements. It's commonly called an Adoption Taxpayer Identification Number (or ATIN in tax speak). This is a temporary ID number issued by the IRS to a child in a domestic adoption when the parents are unable to obtain the child's existing Social Security number, or are unable to apply for a new Social Security number until the adoption is final.

An ATIN can also be used to claim the dependent exemption for the child and the child care credit, but it cannot be used to claim the earned income credit.

An ATIN can be obtained by filing Form W-7A with the IRS, along with a copy of legal placement documentation. The ATIN will remain in effect for two years. And, if you need to keep the ATIN in effect for a longer period of time, an extension is available. For more information, visit the IRS website and download IRS Form W-7A.

In Part III we review the adoption income exclusion... and show you how you might be able to "double dip" a credit and income exclusion if your employer has a qualified adoption plan.
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