Adoptions plummeted during the COVID pandemic, but the adoption rate is slowly rebounding. If you’re among those considering adopting a child, you need to know about the various tax breaks that can make the experience more affordable.
Primary Tax Incentives
The federal tax code includes two subsidies for taxpayers who adopt:
- The adoption credit, and
- An exclusion from income for employer-provided adoption assistance.
These tax breaks cover qualified adoption expenses, including:
- Reasonable and necessary adoption fees,
- Court costs and legal fees,
- Adoption-related travel expenses (for example, meals and lodging), and
- Other expenses directly related to the legal adoption of an eligible child.
Expenses incurred before an eligible child is identified (for example, home studies) can also qualify.
The tax credit is available if you adopt a child (other than a stepchild), whether from the United States or internationally. The child must be under the age of 18 at the time of adoption or physically or mentally incapable of self-care. If adopting from the United States, you also can claim the credit for your expenses for a failed or non-finalized adoption.
How the Credit Works
The adoption credit allows you to reduce your income taxes dollar for dollar. For 2023, the maximum credit is $15,950 per eligible child (up from $14,890 for 2022). It’s nonrefundable, meaning your credit is limited to your federal income tax liability for the year. Any excess credit can be carried forward up to five years.
Both tax breaks may be phases based on your modified adjusted gross income (MAGI). For 2023, the phase-out range is $239,230 to $279,230. If your MAGI equals or exceeds $279,230, you can’t claim a credit or exclusion. (For 2022, the phaseout range was $223,410 to $263,410)
In addition, you must reduce the dollar limit on the tax credit for a particular tax year by the number of qualified adoption expenses you paid and claimed in previous years for the same adoption. For example, if you claimed a $3,000 credit related to a domestic adoption in 2022 and paid an additional $15,950 in 2023 (the year the adoption was finalized), your maximum credit would be $12,950 for 2023 ($15,950 minus $3,000).
Similarly, you must combine expenses claimed for an unsuccessful domestic adoption with the expenses paid for a subsequent domestic adoption attempt, regardless of whether the latter attempt is successful. For instance, suppose you claimed $8,000 in 2021 for an unsuccessful adoption effort. Then you spent another $10,000 on qualified expenses in 2022 and 2023 for a successful adoption that was finalized in 2023. In this scenario, your maximum credit for 2023 would be $7,950 ($15,950 minus $8,000).
You can claim both benefits in the same tax year, but you must first claim any allowable exclusion for employer-provided assistance before claiming credit. And you’ll need to reduce the number of qualified expenses available for the credit by the amount of the exclusion. In other words, you can’t claim both an exclusion and a credit for the same expenses.
The proper tax year in which you can claim the adoption credit depends on:
- When the expenses are paid,
- Whether the adoption is domestic or international, and
- When the adoption was finalized (if applicable).
For domestic adoption, qualified adoption expenses paid before the year that the adoption is finalized can be claimed as a credit for the tax year following the year of payment (even if the adoption is never finalized or an eligible child was never identified).
With a foreign adoption, you can claim the credit for qualified expenses paid before and during the year only in the year the adoption becomes final. After an adoption is final, qualified expenses paid during or after that year are allowed as a credit for the year of payment (subject to the dollar limit), for domestic or foreign adoption.
Children with Special Needs
For domestic adoptions, taxpayers who adopt a child with special needs generally can claim the maximum amount of the credit in the year the adoption goes through, regardless of their actual expenses. However, the maximum credit amount must be reduced by any qualified adoption expenses you previously claimed for the same child, and income phaseouts may apply. You’ll also be eligible for the income exclusion even if you or your employer paid no qualified expenses.
A child has special needs if a state finds that the child 1) can’t or shouldn’t be returned to his or her parent’s home, and 2) probably won’t be adoptable without the assistance provided to the adoptive family. Children with disabilities don’t necessarily qualify as “special needs.” The term generally refers to a child that the state’s child welfare agency considers difficult to place for adoption.
That’s Not All
Adoptive parents may also qualify for other general tax breaks for parents, such as the child tax credit, child and dependent care credit, and dependent care flexible spending accounts. Consult with your tax advisor to ensure you’re claiming all of the benefits to which you’re entitled.