It’s the reason for the season – holiday celebrations and family gatherings – but for many, the month of December can be especially hard. According to a recent report by the U.S. Department of Health and Human Services, there are approximately 430,000 children in foster care, of which approximately 112,000 are waiting to be adopted. Making matters worse is that according to a report by the National Council for Adoption, the number of families willing to adopt is on the decline. A contributing factor can sometimes be the fear of the unknown financial responsibility and economic burden an adoption may have on a family.
However, according to Alison Flores, principal tax research analyst of The Tax Institute at H&R Block, there are several ways families can offset some of the expenses associated with adoption.
Exclusion for Employer Adoption Assistance Program Benefits
Adoptive families should check with their employer to see if it has established an adoption assistance program as a benefit for eligible associates that can be used to reimburse all or a portion of the cost of adopting a child. Up to $13,570 (for 2017) qualifying benefits paid to associates under the program are tax-free.
Adoption Tax Credit
Adoptive families may also take advantage of the federal adoption tax credit which is worth up to $13,570 (for 2017) for each child they adopt. How much they will benefit from the credit depends on their income, federal income tax liability—which is the amount they are responsible for in federal income taxes—and other credits they claim. If they can’t use all of the credit in the year they claim it, they can carry the remainder forward for up to five more years to offset any of those years’ federal tax liability.
Both the adoption exclusion and the adoption credit are subject to income limits. Taxpayers with adjusted gross income over $243,540 (for 2017) can’t claim any adoption benefits.
Taxpayers can claim both the credit and the exclusion for expenses related to adopting a child. Taxpayers usually can’t claim both tax benefits for the same expenses. However, taxpayers who adopt a U.S. child with special needs can claim an exclusion (if the employer has a written qualified adoption assistance program), even if the employee didn’t pay any qualified adoption expenses, and a credit. A special needs child is one the state’s child welfare agency considers difficult to place for adoption.
Qualifying expenses include:
Travel expenses and
Other adoption costs.
For a taxpayer’s expenses to qualify for the credit or exclusion, both of these must apply:
The adopted child must be under age 18 or disabled.
The taxpayer paid qualifying expenses in the tax year in which the credit is claimed.
Note: for the adoption of a foreign child the credit or exclusion cannot be claimed until the year in which the adoption is finalized.
Adoptive families may also explore their 401(k) plan and see if it allows them to take out a loan for an adoption. They may be able to borrow a maximum of $50,000 or 50 percent of their vested account balance, whichever is less. The interest rate on a 401(k) loan is determined by the rules in the 401(k) plan, but it’s usually minimal. Taxpayers can then repay the loan by setting up automatic deductions from their paycheck. However, if a taxpayer defaults on the loan because the taxpayer doesn't repay the loan on time or loses their job while they have an outstanding 401(k) loan, then the outstanding balance will be treated like a distribution. This means taxes and early distribution penalties may be due.
Monetary Gifts from Friends and Family/Crowdfunding Donations
Taxpayers could consider asking friends and family members if they are willing to make a monetary gift or set up a crowdfunding site to help cover adoption expenses.
If someone gives a monetary gift and there’s no business or potential profit motive, then the recipient doesn’t have to report it as taxable income.
Adoptive families might also think about ways they can fundraise on their own such as through a garage sale, car wash or spaghetti dinner. Keep in mind however, that while some types of activities generally don’t generate taxable income (such as garage sales), some activities will generate taxable income (such as selling a product or service).
There are many churches, nonprofit organizations and foundations that will grant families free and clear money in the form of a grant to cover adoption expenses. Often the recipients of these grants are families who are financially needy and they aren’t required to report the grant as taxable income.
To learn more about the tax benefits and consequences before, during or after an adoption journey, it’s best to consult a tax professional.