Posted by Flynn Financial Group Inc

What Adoption Tax Credit Is All About

What Adoption Tax Credit Is All About

In 2018, for all qualifying adoption expenses up to $13,810 taxpayers can receive a tax credit. The maximum credit is indexed for inflation. Up to the same limit as the credit, taxpayers may also exclude from income qualified adoption expenses paid or reimbursed by an employer. Though taxpayers can use the tax credit and the income inclusion they cannot claim the same expenses for both.  

Regardless of out-of-pocket expenses, special needs adoption automatically qualify for the maximum credit. If a state’s welfare agency determines a child cannot or should not be returned to his or her parent’s home and that child will not be adoptable without the assistance provided to the adoptive family, then for the purposes of the credit, that child has special needs. To encourage parents to adopt children who would otherwise be hard to place even if most of the adoption expenses are covered by someone else such as a foster care program is the main intent of this provision. 

With some exceptions, the adoption credit is available to most adoptive parents. To taxpayers whose income exceeds a certain threshold that is indexed for inflation, then the credit is not available for them. In 2018, at $207,140 is where the credit begins to phase out of modified adjusted gross income and at an income of $247,140 it phases out entirely. For adoptions of stepchildren, this credit is not available. 

The adoption tax carried can be carried forward for up to five years but it is nonrefundable. For low-income families who pay little or no income tax over a period of years,  the credit is thus of no or little value. For 2010 and 2011, the adoption tax credit was made refundable by the Patient Protection and Affordable Care Act of 2010. The Internal Revenue Service (IRS) stepped up compliance efforts concerning the potential for fraud. According to the National Taxpayer Advocate Service, the result was substantial delays for taxpayers with 69 percent of all adoption credit claims filed in 2012 selected for audit. The IRS ultimately disallowed only 1.5 percent of claims, and to taxpayers with delayed refunds-- 20 percent of the savings from the disallowed credits was spent on the interest they owe. In 2012, the credit reverted to nonrefundable. 

From an initial value of $5,000 in 1997 to $13,810 in 2018, the credit has been repeatedly expanded. Taxpayers claimed total adoption credit of $290 million in 2016. The dramatically higher figures of $1.2 billion in 2010 and $610 million in 2011 (including the refundable option) cost of credit was being pushed by the temporary availability of refundable credit.

The distribution of the credit across income group ranges from substantial amounts to those with upper-middle incomes, small amounts for low- and moderate income households (because of their minimal tax liability and the credit’s nonrefundability) and to the highest income households (because of the income cap). In the tax year 2016 for example, the average credit is $2,388 per adoption for those with incomes between $50,000 and $75,000 which is almost one-third of claimants, while the average credit is $7,233 per adoption for households with incomes between $100,000 and $200,000 which is about 30 percent of claimants. 

What is child tax credit and how does it differ from the adoption tax credit?

For each child under age 17 who is a citizen, taxpayers can claim a child tax credit (CTC) of up to $2,000. Over $200,000 for single parents, the credit is reduced by 5 percent of adjusted gross income while $400,000 for married couples. Additional child tax credit (ACTC) or refundable CTC is where taxpayers can receive up to $1,400 of the balance a refund if the credit exceeds taxes owed. For earnings above $2,500, the ACTC is limited to 15 percent of earnings. 

The CTC is not indexed for inflation for the most part. The amount of credit is the exception to what families with children under 17 can receive as a refund. After 2018, the current amount which is $1,400 will increase with inflation until it becomes equal to the full value of the credit which is $2,000.

For those who are not eligible for the $2,000 CTC for children under 17, a $500 credit is available to dependents starting in 2018. These individuals before 2018 would not have qualified for a tax credit but they would have qualified for a dependent exemption which the 2017 Tax Cuts and Jobs Act (TCJA) eliminated. These include children ages 17-18 or those 19-24 and at least in school full time in at least five months of the year. Representing about 6 percent of dependents eligible for the CTC are older dependents which are also included. 

To revert to its pre-TCJA form is what the CTC is scheduled after 2025. At that point, for each child under the age of 17, taxpayers will be able to claim a credit of up to $1,000. The credit will be reduced by 5 percent of adjusted gross income over $75,000 for single parents and $110,000 for married couples. Taxpayers will be able to receive the balance as a refund if the credit exceeds taxes owed. For the earnings above $3,000, the refundable portion of the credit will be limited to 15 percent.

Flynn Financial Group Inc
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