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Maximize credit for adoption expenses

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in Small Business Tax,Small Business Tax Deduction Strategies

The impending “fiscal cliff” isn’t the only im­­por­­tant tax issue facing Congress. The tax breaks available for adopting a child will be drastically scaled back in 2013 unless the rules are changed.

Strategy: Learn the rules for the “adoption credit” inside out. This will enable you (or another family member) who is adopting a child to maximize the tax benefits under current law.

The adoption credit reduces your tax bill on a dollar-for-dollar basis. It phases out for high-income taxpayers, but many parents are eligible for at least a partial credit.

Here’s the whole story: For 2012 tax returns, the maximum adoption credit is equal to $12,650 of the qualified expenses incurred to adopt an eligible child (down from $13,360 in 2011). An “eligible child” is one who is under age 18 or physically or mentally incapable of caring for himself or herself. Other rules apply to “special needs” children (see box below).

The credit phases out in 2012 for taxpayers with modified adjusted gross income (MAGI) above $189,710. The phaseout is complete when MAGI reaches $229,710. No credit is allowed after that point.

The credit covers all of the reasonable and legal costs directly related to the adoption. These include:

  • Adoption agency fees
  • Court costs
  • Attorneys’ 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 fees that violate state or federal laws, surrogate parenting fees or amounts reimbursed by a government entity or your employer.

The credit is generally available in the year that qualified expenses are paid or incurred. However, if the adoption isn’t finalized by the end of the year, 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 isn’t finalized that year.

Caveat: The credit can’t be claimed for a foreign child until the year in which adoption is final.

Also, the credit for 2012 is no longer refundable. In other words, the family can benefit only if it has a tax liability. Any remaining credit may be carried forward for five additional years until the credit is used up or time runs out. Absent any new legislation, the credit will be available in 2013 only to families adopting special-needs children, and the maximum credit will be only $6,000. There will be no credit at all for adopting other children. As this is being written, Congress is facing pressure to restore the credit for other adoptions.

Tip: Although the credit for nonspecial-needs children could be renewed, there’s a strong possibility that the provisions won’t be as favorable as they were in the past.

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