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Don’t be shortchanged on the adoption tax credit

by on
in Small Business Tax

Trying to adopt a child can be a gut-wrenching experience. But all the hassle and expense is worthwhile when you finally bring home your little bundle of joy.

Strategy: Recoup part of the cost through tax breaks. You can claim a significant tax credit—a dollar-for-dollar reduction of your tax bill—for qualified adoption expenses.

The adoption credit phases out for certain upper-income taxpayers, but most young parents can claim at least a partial tax credit. Figure in the tax “bennies” if you or another family member— perhaps an adult child—is considering this option.

Here’s the whole story: For 2007, the maximum adoption credit is equal to $11,390 of the qualified expenses paid to adopt an eligible child (up from $10,960 for 2006). An “eligible child” is a child either under age 18 or physically or mentally incapable of caring for itself.

What expenses qualify? All reasonable and legal costs directly related to the adoption. This includes:

  • Adoption agency fees.
  • Court costs.
  • Attorney’s fees.
  • Travel costs while away from home (including meals and lodging).
  • Re-adoption expenses to adopt a foreign child.

On the other hand, you can’t claim the credit for any illegal fees, surrogate parenting fees or amounts reimbursed by a government entity or your employer (see box).

If you adopt a “special needs” child (i.e., one whom the state has determined is not likely to be adopted without special assistance), the maximum credit is allowed regardless of the amount actually spent for the adoption. For instance, if you spend only $1,000 adopting a special needs child, you can still claim the full $11,390 credit. The special needs child must be a citizen or resident of the United States.

The credit phases out for taxpayers with an AGI in 2007 of between $170,820 and $210,820. No credit is allowed if your AGI exceeds the $210,820 mark.

When do you claim the credit? Generally, the credit is available in the year that qualified expenses are paid or incurred. However, if the adoption is not final at year-end, the credit can’t be claimed until the following year. Once you reach the second year, the credit is available for previous expenses, even if the adoption is not finalized that year.

For a foreign-born child, you can’t claim any credit until the year in which the adoption is final. All prior expenses are lumped together for that year. Any subsequent expenses may be claimed in the year in which they are paid or incurred.

Is that all there is? Not by a long shot. Besides the big tax credit, you may be in line for other tax benefits as a result of adopting a child, such as an extra dependency exemption, the regular “child tax credit” and medical expense deductions for expenses paid on behalf of the adopted child. Those tax breaks are also subject to certain phaseouts based on AGI.

Tip: Claim the adoption credit on Form 8839, Qualified Adoption Expenses. Find it at www.irs.gov/pub/irs-pdf/f8839.pdf.

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