Q: I hate to admit it, but I have read and studied and still don’t understand the adoption tax credit and how it works. Can you help me?
–Shari T. in California
A: Shari, you aren’t alone! Let’s try to get it in easy-to-understand terms by telling a story…
Jim and Kathy decided to adopt in 2010. In that year, they paid for their home study, their adoption facilitator, and their profiles.
They were chosen by a birthmother in 2011 and paid for an attorney, travel to get their baby, and other legal fees required by their state.
In 2012, they finalized their adoption legally. They added up all the costs mentioned above (because they remember to keep their receipts) and it totaled $25,000 in total adoption costs.
Now, here we are in 2013 and Jim and Kathy are doing their taxes for 2012. They complete their 1040 form with all their W-2 and interest income, itemized deductions, and find they owe $27,000 in taxes (before taking into account any withholding).
They know that because 2012 was the year they finalized their adoption, this is the year they need to complete IRS Form 8839 for Qualified Adoption Expenses. At the end of From 8839, their calculate their taxable benefit for adoption expenses to be $12,650 (the maximum allowed for 2012). So they put $12,650 on the appropriate line of their 1040 in the Tax Credits Section. They also get a Child Tax Credit of $1,000 because they have a child. So their total credits are $13,650.
As instructed, they subtract that from the tax owed and now their tax is $13,350.
Now, Jim and Kathy are good planners and they don’t like writing a check to the IRS at tax time so they try to have plenty deducted from their paychecks to ensure that is the case. Their total withholdings for the year are $25,000. And they enter those in the appropriate place on their 1040.
So, total tax of $13,350 less their total withholdings of $25,000 mean they are getting a refund of $11,650. In this case, it was only due to the fact that they adopted a child and had qualifying adoption expenses. Had they not adopted, they would have not received the refund of withholdings because their total tax would have been the full $27,000 and they actually would have had to pay an additional $2,000.
In less detailed terms, they spent $25,000 on their adoption and received a credit to their federal taxes of $12,650 which resulted in a refund of their tax withholdings for the year.
In even less detailed terms, their adoption ended up costing $12,350.
Please note: Lifetime Adoption is not a qualified tax advisor. This article is for educational purposes and should not be taken as tax advice or expertise. Please consult your CPA. Every adoption is different and may be subject to income limitations or other things.