Making Sure You Get the Adoption Tax Credit

Sometimes I feel like there’s a tax credit for everything—but the tricky part is finding out for which tax credits you qualify and how to receive them. One interesting and important tax credit that may be available to you is the adoption credit.

Why do we care so much about the adoption tax credit?

The adoption tax credit is one of the most generous of all refundable credits. For 2010 and 2011, it’s worth $13,170 and $13,360 respectively—per child. Your employer may also pay an equal amount of money towards your adoption costs if your costs exceeded your credit. That’s a lot of money that could go toward helping you achieve your financial goals.

How do you qualify for this tax credit?

You must adopt a child (or children). The child being adopted must either be under age 18 or be someone who is unable to care for him or herself.

Even if you have no out-of-pocket expenses related to the adoption, you may be able to claim the full credit if you adopt a child with special needs. There are special rules for adopting children who might otherwise never get adopted. (For more information, see page 7 of the instructions to Form 8839.)

What else do you need to know about the adoption tax credit?

The adoption must be final when you take the credit.
If you pay any expenses before the adoption is final, you may claim the expenses in the year after you paid them, whether or not that is the same year that the adoption is finalized.
If you paid additional expenses in the year after the adoption is final, you may claim the expenses in the year you pay them—after deducting any credit you may have already received.
When adopting foreign children, the credit may only be taken when the adoption is finalized.
If you are married, unless you lived apart for more than the last six months of the year, you must file a joint return to claim the credit.
The child you adopt cannot be related to you by blood or marriage—adopting your step-children doesn’t generate a credit, as the Holloways learned in an IRS audit of their 2002 tax return. (See the Tax Court case Holloway v Comm.)

Kelly’s story: Adopting a stepchild after a divorce

In the TaxQuips forum, a woman named Kelly posted when her adoption tax credit was denied. Whether the IRS is right or not remains to be seen, but her case brings up some important issues.

Kelly got divorced. And after the divorce, when she was no longer related to her former husband or his child, she formally adopted her ex-husband’s child.

The question becomes whether Kelly is considered to be related to the boy because he used to be her stepson. According to the IRS’s rules about related parties for gift taxes, business ownership, and so forth, relationships that were created during a marriage remain intact, even after a divorce. But does that rule apply to adoption?

Kelly’s situation is worth taking to Tax Court for the judge to decide. Unfortunately, Kelly claimed the tax credit early—in the year before the adoption was final. We advised her to let it go for 2010 but to claim it in 2011. When it’s denied, she can then file in Tax Court and see what happens. It’s quite possible that the Court might decide in her favor.

Is it too costly for her to gamble and file in Tax Court? Anyone may file his or her own case, paying a fee of only $60, and the judges are usually quite gracious to folks representing themselves. So it is likely worth her time and money to take this route.

Eva Rosenberg, EA is the publisher of TaxMama.com , where your tax questions are answered. Eva is the author of several books and ebooks, including the new edition of Small Business Taxes Made Easy. Eva teaches a tax pro course at IRSExams.com and tax courses you might enjoy at http://www.cpelink.com/teamtaxmama.