I seem to be running across more and more questions about the adoption tax credit and how it works. Since I got a head start on my taxes, and have thus put a little time into figuring out how it works, I thought I would share. As a disclaimer, I am not a tax adviser, accountant or anything else official. If you have questions, call the IRS hotline, they are actually quite nice and can usually help you (but sadly, not always- I've called many a time so I know). Or I guess you could pay someone to do your taxes.
Short Version:
Add up your allowed adoption expenses.
Subtract grants and employer benefits.
Claim leftover amount, up to $13,170, as your credit.
Wait for your check.
Here is the longer, more complicated, but also more informative version of how you prepare for filing the adoption tax credit:
First, you must keep track of all of your allowable expenses while you are adopting. If you can, pay either with check or credit card, and get receipts whenever possible. While you are in country keep a little notebook with you to track your cash spending. Put in in your purse/backpack/diaper bag and make a habit of recording your cash spending as soon as that money leaves your hands. You may not be able to get a receipt at say, the fruit market or rolex stand, but be sure and record what you spent precisely so that you have a record of it. You will need those proofs if the IRS decides to audit you. Also, you will get receipts when you withdraw currency from either an ATM or when you go to exchange your US dollars for foreign currency. Keep those receipts as well to back up your cash spending record.
Allowable expenses are those "reasonable and necessary expenses related to a legal adoption" that you paid out of pocket. This includes (but is not limited to): agency fees, lawyers fees, court costs, fees related to the preparation of your dossier (fingerprints, required training, document costs, notary, apostilles, etc), fees for any other required documents, and travel expenses. Travel expenses also need to be "reasonable and necessary" and "related to your adoption." According to the IRS tax topic (607, if you want to look it up) this includes travel costs (airfare, transportation in country) and costs related to meals and lodging. Although all adoptive parents know that it is necessary to do some sight-seeing and bring home items from your child's country, it is worth noting that the IRS did not include those things under their guidelines of allowable expenses. I've read that the question you should ask yourself is "could the adoption have been completed without paying this fee/expense?" if the answer is no then that expense is eligible. But things like a poster of native animals that your child needs to connect with their culture, or extra donations to your orphanage (those requested but not required, for example we bought some bags of food for the kids when we visited and a bunch of clothes and toys), visits to museums or cultural centers (unless required by your country or agency as part of the process), or trips to the pool to save your sanity cannot be claimed.
On a quick side note, any donations that you make to your child's orphanage can be deducted if you itemize instead of taking the standard deduction. However, you cannot claim a donation as an adoption expense and also as a deduction. Also, claiming anything labeled as a donation as an adoption expense is a bit murky. From reading some message boards on this topic, it appears that most accountants tell clients that fees labelled "donations" can be counted as fees IF (note the theme) they are actually required for the completion of an adoption. I read about this in the context of Chinese adoption, because the government has a mandatory "orphanage donation" of a few thousand dollars. This expense is not a gift, because you cannot complete your adoption without paying it. Thus, families adopting from China who pay this claim it as an adoption expense. If you do make a donation that is requested but not required, you may not be able to claim it as an allowable expense for the tax credit (but could claim it as a deduction).
Now that you have all of your receipts out and have added up all your expenses, you need to confirm that you spent over 13,170 (haha- of course you did). The other thing you need to check is how much you received in grant money or employer adoption benefits. You can't double dip here. Let's say you spend 25K. The tax credit is a little over 13K. If you get a 3K adoption benefit at work, and also received a 10K grant (unlikely, but this is for the sake of argument), then your total grants/credits, including the tax credit would be 26K, a full 1K more than you spent. You aren't allowed to make money on your adoption (although it is unlikely you would, because most grant organizations will be careful not to give too large of grants, and most work benefits require you prove costs above the tax credit before they will cut you a check). That said, before you can claim the tax credit you must subtract from your total costs any money you received from any organization or employer that was intended for the costs of your adoption.
You do a have a little wiggle room- donations made directly to you by your relatives or friends as personal gifts to help with the adoption can be used on those things that are not required (like donations to your orphanage, sight-seeing, etc) and on those things that you might not have the best documentation for. We were even given some money with a note saying we could spend it on getting Tommy something from his country- obviously I would not claim the things I bought Tommy as required adoption expenditures, but nor would we need to subtract the personal gift from our adoption costs before claiming the credit. The IRS allows each person to receive up to $11,000 a year in gifts tax-free (which is why you never think about adding up and reporting the value of the birthday and Christmas presents you receive). So any money given as a gift- that is- from an individual- with nothing of monetary value received in return- does not have to be subtracted from your claimed costs and can be used for those expenditures like visiting a museum or giving to a church you visit, or meeting a need you see at the orphanage or among the people you meet(and you will see plenty) that we all know are necessary to do, but that the IRS does not view as necessary for completing your adoption.
The only other wrinkle here is money that you may have raised for your adoption. Lots of families fund raise to help with expenses. Now, if you fund raised through a non-profit that provided a tax deduction to those who purchased something or donated, the money you raised would be treated as a grant. However, if you raised money as a private individual directly by selling something and making a profit, then that profit (not total money taken in, just profit) must be reported as part of your regular income. The bummer is, you have to pay taxes on the money you raised. The bright side is that you don't have to mess with subtracting that income when you are dealing with the tax credit. For example, if you raised 10K (again, highly unlikely, I know) by selling soaps or t-shirts or coffee, you must report that money as income because it is income. But, legally you would not need to subtract it from your total adoption costs before claiming the credit. You might decide to donate any extra to someone else who is adopting or use it for another adoption, just as a matter of conscience, but that has nothing to do with the IRS.
Ok, so back to that 1040. The adoption tax credit is a refundable credit.
No one pays taxes on their whole income. We all know about income deductions, exemptions, and adjustments that help to lower the taxes we pay each year. Those things reduce the amount of income you pay tax on. For example, a married couple making 50K gets to take a standard deduction of about 11K (it's a bit over that, but lets use round numbers). If they have two kids and have contributed to an IRA or spent money on certain things, like higher education, they might have another 16K to subtract from their income. So, their taxable income (adjusted down from 50K) is 23K. The tax they owe is $2,600.
Now, on to credits. Say they have 2K in credits, and had 2K of income tax withheld from their paychecks.
Their total owed is $2,600
Their total payments/credits were $4,000
Now, lets say that one of their two children was adopted and their adoption was finalized that year.
Now their total owed is still $2,600 but their total credits, including the adoption tax credit of 13,000 are 17,000.
Now some credits are refundable, some carry forward (this is how the adoption tax credit used to be) and some are not useful if you can't take advantage of them right then- they expire yearly. The adoption tax credit is now refundable, which means, if you don't owe the taxes, the government will send you check for the credit.
So, the couple can subtract from their tax bill their 2,00O in regular credit (unrelated to the adoption), and they are left with a tax bill of 600. They have paid 2000 into the system and are owed the adoption tax credit of 13,000. The couple must still pay the 600 in taxes they owe, BUT, they can then get back all of their remaining tax payments, and their adoption tax credit. Their total refund check would be about $14,600 in this scenario. That refund number reflects them receiving back a portion of the money they paid for their taxes that they ended up not owing, as well as the credit for money they spent on their adoption.
What we did- our adoption finalized in January 2010, right before Jeff started his new job. When he filled out his paperwork, we filed an outrageously high number of exemptions and we have not paid any federal income tax into the system this year because we wanted the money to start adopting again and we knew that we would not owe taxes. This would be a risky move to make if you were not positive that you were finalizing, but since we finalized so early in the year it made sense for us. We still pay state and payroll taxes (social security) of course, but it put the money we would get back later into our pockets more quickly. Of course, our "big check" come April won't be so big...but it will still be better than nothing!
I hope this is helpful. I will update it after I get the new tax forms and actually do my taxes if I think of anything else that needs to be said. (Or if you have a question/see a problem email me and I'll either try and answer or fix my error). Have fun crunching your numbers! Or at least have fun cashing that check!
Short Version:
Add up your allowed adoption expenses.
Subtract grants and employer benefits.
Claim leftover amount, up to $13,170, as your credit.
Wait for your check.
Here is the longer, more complicated, but also more informative version of how you prepare for filing the adoption tax credit:
First, you must keep track of all of your allowable expenses while you are adopting. If you can, pay either with check or credit card, and get receipts whenever possible. While you are in country keep a little notebook with you to track your cash spending. Put in in your purse/backpack/diaper bag and make a habit of recording your cash spending as soon as that money leaves your hands. You may not be able to get a receipt at say, the fruit market or rolex stand, but be sure and record what you spent precisely so that you have a record of it. You will need those proofs if the IRS decides to audit you. Also, you will get receipts when you withdraw currency from either an ATM or when you go to exchange your US dollars for foreign currency. Keep those receipts as well to back up your cash spending record.
Allowable expenses are those "reasonable and necessary expenses related to a legal adoption" that you paid out of pocket. This includes (but is not limited to): agency fees, lawyers fees, court costs, fees related to the preparation of your dossier (fingerprints, required training, document costs, notary, apostilles, etc), fees for any other required documents, and travel expenses. Travel expenses also need to be "reasonable and necessary" and "related to your adoption." According to the IRS tax topic (607, if you want to look it up) this includes travel costs (airfare, transportation in country) and costs related to meals and lodging. Although all adoptive parents know that it is necessary to do some sight-seeing and bring home items from your child's country, it is worth noting that the IRS did not include those things under their guidelines of allowable expenses. I've read that the question you should ask yourself is "could the adoption have been completed without paying this fee/expense?" if the answer is no then that expense is eligible. But things like a poster of native animals that your child needs to connect with their culture, or extra donations to your orphanage (those requested but not required, for example we bought some bags of food for the kids when we visited and a bunch of clothes and toys), visits to museums or cultural centers (unless required by your country or agency as part of the process), or trips to the pool to save your sanity cannot be claimed.
On a quick side note, any donations that you make to your child's orphanage can be deducted if you itemize instead of taking the standard deduction. However, you cannot claim a donation as an adoption expense and also as a deduction. Also, claiming anything labeled as a donation as an adoption expense is a bit murky. From reading some message boards on this topic, it appears that most accountants tell clients that fees labelled "donations" can be counted as fees IF (note the theme) they are actually required for the completion of an adoption. I read about this in the context of Chinese adoption, because the government has a mandatory "orphanage donation" of a few thousand dollars. This expense is not a gift, because you cannot complete your adoption without paying it. Thus, families adopting from China who pay this claim it as an adoption expense. If you do make a donation that is requested but not required, you may not be able to claim it as an allowable expense for the tax credit (but could claim it as a deduction).
Now that you have all of your receipts out and have added up all your expenses, you need to confirm that you spent over 13,170 (haha- of course you did). The other thing you need to check is how much you received in grant money or employer adoption benefits. You can't double dip here. Let's say you spend 25K. The tax credit is a little over 13K. If you get a 3K adoption benefit at work, and also received a 10K grant (unlikely, but this is for the sake of argument), then your total grants/credits, including the tax credit would be 26K, a full 1K more than you spent. You aren't allowed to make money on your adoption (although it is unlikely you would, because most grant organizations will be careful not to give too large of grants, and most work benefits require you prove costs above the tax credit before they will cut you a check). That said, before you can claim the tax credit you must subtract from your total costs any money you received from any organization or employer that was intended for the costs of your adoption.
You do a have a little wiggle room- donations made directly to you by your relatives or friends as personal gifts to help with the adoption can be used on those things that are not required (like donations to your orphanage, sight-seeing, etc) and on those things that you might not have the best documentation for. We were even given some money with a note saying we could spend it on getting Tommy something from his country- obviously I would not claim the things I bought Tommy as required adoption expenditures, but nor would we need to subtract the personal gift from our adoption costs before claiming the credit. The IRS allows each person to receive up to $11,000 a year in gifts tax-free (which is why you never think about adding up and reporting the value of the birthday and Christmas presents you receive). So any money given as a gift- that is- from an individual- with nothing of monetary value received in return- does not have to be subtracted from your claimed costs and can be used for those expenditures like visiting a museum or giving to a church you visit, or meeting a need you see at the orphanage or among the people you meet(and you will see plenty) that we all know are necessary to do, but that the IRS does not view as necessary for completing your adoption.
The only other wrinkle here is money that you may have raised for your adoption. Lots of families fund raise to help with expenses. Now, if you fund raised through a non-profit that provided a tax deduction to those who purchased something or donated, the money you raised would be treated as a grant. However, if you raised money as a private individual directly by selling something and making a profit, then that profit (not total money taken in, just profit) must be reported as part of your regular income. The bummer is, you have to pay taxes on the money you raised. The bright side is that you don't have to mess with subtracting that income when you are dealing with the tax credit. For example, if you raised 10K (again, highly unlikely, I know) by selling soaps or t-shirts or coffee, you must report that money as income because it is income. But, legally you would not need to subtract it from your total adoption costs before claiming the credit. You might decide to donate any extra to someone else who is adopting or use it for another adoption, just as a matter of conscience, but that has nothing to do with the IRS.
Ok, so back to that 1040. The adoption tax credit is a refundable credit.
No one pays taxes on their whole income. We all know about income deductions, exemptions, and adjustments that help to lower the taxes we pay each year. Those things reduce the amount of income you pay tax on. For example, a married couple making 50K gets to take a standard deduction of about 11K (it's a bit over that, but lets use round numbers). If they have two kids and have contributed to an IRA or spent money on certain things, like higher education, they might have another 16K to subtract from their income. So, their taxable income (adjusted down from 50K) is 23K. The tax they owe is $2,600.
Now, on to credits. Say they have 2K in credits, and had 2K of income tax withheld from their paychecks.
Their total owed is $2,600
Their total payments/credits were $4,000
Now, lets say that one of their two children was adopted and their adoption was finalized that year.
Now their total owed is still $2,600 but their total credits, including the adoption tax credit of 13,000 are 17,000.
Now some credits are refundable, some carry forward (this is how the adoption tax credit used to be) and some are not useful if you can't take advantage of them right then- they expire yearly. The adoption tax credit is now refundable, which means, if you don't owe the taxes, the government will send you check for the credit.
So, the couple can subtract from their tax bill their 2,00O in regular credit (unrelated to the adoption), and they are left with a tax bill of 600. They have paid 2000 into the system and are owed the adoption tax credit of 13,000. The couple must still pay the 600 in taxes they owe, BUT, they can then get back all of their remaining tax payments, and their adoption tax credit. Their total refund check would be about $14,600 in this scenario. That refund number reflects them receiving back a portion of the money they paid for their taxes that they ended up not owing, as well as the credit for money they spent on their adoption.
What we did- our adoption finalized in January 2010, right before Jeff started his new job. When he filled out his paperwork, we filed an outrageously high number of exemptions and we have not paid any federal income tax into the system this year because we wanted the money to start adopting again and we knew that we would not owe taxes. This would be a risky move to make if you were not positive that you were finalizing, but since we finalized so early in the year it made sense for us. We still pay state and payroll taxes (social security) of course, but it put the money we would get back later into our pockets more quickly. Of course, our "big check" come April won't be so big...but it will still be better than nothing!
I hope this is helpful. I will update it after I get the new tax forms and actually do my taxes if I think of anything else that needs to be said. (Or if you have a question/see a problem email me and I'll either try and answer or fix my error). Have fun crunching your numbers! Or at least have fun cashing that check!
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4 comments:
I need to forward this to my sister!! Thanks, Amy.
You. Are. A. ROCK. STAR. Thank you so much, this is so helpful!!
Very Good info. Thanks!
Here is the newest thing on this. Obviously the IRS has decided to Audit most of the people who are claiming the ATC which is really nasty since this Credit was supposed to help ofset the high cost of adoption. I do not know anybody who did not pay about 20000 - 45000 $ for their adoption, domestic or internationally. I read on many adoption chats how the IRS is stalling those refunds. You get the rest which has nothing to do with the ATC but the rest...you might have to wait .....
I called my local news station and I suggest to sound off as well. We have to mail in our adoption decree and that is not enough prove. Its from the Court for crying out loud!!! Ridiculous.
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