How the Federal Adoption Tax Credit Works

Adoption is a wonderful way to grow a family and give a child in need a home. But the process can be prohibitively expensive. In fact, the average cost of a private agency adoption in the U.S. is $43,000, according to a report from Adoptive Families Magazine. That's because there are numerous expenses that go into the process:

Attorney fees

Court fees

Home studies

Travel expenses

The good news, however, is that the IRS makes it easier on families to cover these and other qualifying expenses via the federal adoption tax credit.

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How the adoption tax credit works

A tax credit is a dollar-for-dollar reduction of your tax liability. If you owe $1,000 on your taxes but then claim a $1,000 tax credit, that debt is instantly wiped out.

Some tax credits are refundable, which means they'll pay you even if you don't owe any tax. Most, however, are non-refundable, which means the most they can do is reduce your tax liability to $0. The adoption tax credit is non-refundable, but it can be carried forward up to five years. This means that if you have a $10,000 credit but can only use $3,000 of it your first year, you get four more years to use up the remaining $7,000.

To qualify for the adoption tax credit, you must adopt a child under the age of 18. It doesn't matter, however, whether you adopt that child via the foster care system or a private agency, and both domestic and international adoptions count. However, adopting a stepchild doesn't render you eligible for the credit.

How much is the adoption tax credit worth?

In 2020, the adoption tax credit could be worth up to $14,300. In 2021, its value increases to $14,440. To claim the maximum credit, however, you need to rack up that much in eligible expenses. Given the typical cost of adoption, though, that may not be an issue.

Are there income limits associated with the adoption tax credit?

Many popular tax credits start to phase out for higher earners, and the same holds true for the adoption tax credit. However, the income thresholds for eligibility are pretty generous. In 2020, the credit begins to phase out for filers with a modified adjusted gross income (MAGI) of $214,520, and the credit is off limits for a MAGI of $254,520 or higher.

In 2021, these limits are rising slightly. The credit will start to phase out with a MAGI of $216,600 and will be off the table for a MAGI of $256,660 or above.

How to claim the adoption tax credit

Adoption can be a multi-year process, and for domestic adoptions, you're allowed to claim the adoption tax credit for the tax year in which expenses are incurred. For example, say you begin the adoption process in 2018, during which you spend $5,000, and you finalize the process in 2019, spending another $5,000. You can claim the first $5,000 on your 2018 tax return and then claim the remainder on the following year's tax return. If you're doing an international adoption, however, you can only claim the credit in the year the adoption becomes final. It's important that you keep good records so you know what expenses to claim.

Though adoption is a wonderful thing, the process can be stressful as well as expensive. Thankfully, many families are eligible for relief in the form of the adoption tax credit. If you're thinking of adopting and are worried about the costs involved, it pays to consult with a tax professional and see how to maximize the credit given your financial situation.

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