The adoption tax credit for families with children: tax year 2021

The tax law has become increasingly family focused in recent years, providing tax breaks for families with children including tax credits for children, tax breaks for child care, tax-favored accounts for education savings, and much more. However, to make the best use of these tax benefits, families must understand how they work. Here is an excerpt of the white paper “Tax strategies for families with children” that covers several of these child-centered tax benefits—and highlight tax strategies for maximizing tax savings and avoiding potential pitfalls. Feel free to pass this information on to clients to help them understand their options.

Adoptive parents may claim an income tax credit for qualified adoption expenses for an eligible child (Code Sec. 23). An eligible child is a child under 18 at the time the expenses are paid or an individual incapable of self-care. The credit is subject to a phase-out for higher-income taxpayers. The maximum credit and the phase-out threshold are subject to annual inflation adjustments.

The maximum credit is $14,440 for 2021, for both special needs and non-special needs adoptions. In the case of the adoption of a child with special needs, the maximum credit is allowable without regard to the actual amount of adoption expenses. For 2021, the credit begins to phase out for taxpayers with modified adjusted gross income (AGI) over $216,660, and is fully eliminated at modified AGI of $256,660. Married individuals must file jointly to claim the credit.

In the case of a domestic adoption, the credit for an expense paid or incurred before the tax year in which the adoption becomes final is allowed for the tax year following the tax year during which it is paid or incurred. For an expense paid or incurred during or after the tax year in which the adoption becomes final, the credit is allowed for the tax year in which the expense is paid or incurred.

The credit for a foreign adoption isn’t allowed unless the adoption becomes final. Expenses paid or incurred in the year the foreign adoption is finalized or in an earlier year are allowed in the year the adoption is final. Expenses after the year the foreign adoption becomes final are taken into account when paid or incurred.

Qualified adoption expenses include reasonable and necessary adoption fees, court costs, attorney fees, and other expenses that are directly related to, and the principal purpose of which is, the taxpayer’s legal adoption of an eligible child.

An employee may exclude adoption assistance provided by an employer for qualified adoption expenses connected with the employee’s adoption of a child (Code Sec. 137). The exclusion for adoption assistance is subject to the same dollar limit and phaseout thresholds as the adoption tax credit. The dollar limit applies to the adoption of each child and is cumulative for all tax years (rather than an annual limit). In the case of an adoption of a child with special needs, the exclusion applies regardless of whether the employee has qualified adoption expenses. A taxpayer can’t claim an adoption credit for any employer-paid adoption expenses.

Editor’s note: Robin Gervais, EA, and Sarah Molouki, CPA, MS in Tax, contributed to this article.