New Changes to the Federal Adoption Tax Credit

by Mark Demaray on March 31, 2010

The new Health Care Bill recently signed into law by President Obama includes some important changes to federal law relating to the Adoption Tax Credit.  The former law that allowed for the Adoption Credit was enacted some 10 years ago and had what is known as a “sunset clause” — which meant that the law that allowed a federal tax credit for adoption expenses was to expire and cease to be the law as of December 31, 2010.   This law was amended in the new Health Care Bill such that the Adoption Tax Credit is extended for another year – through December 31, 2011 — and the maximum amount of allowable tax credit was raised from $12,170 to $13,170.  Also, any qualifying adoption occurring after January 1, 2010 is now eligible for that higher tax credit amount.   Also of great importance is a change that makes the tax credit now a “refundable” one — which means that even in adoptions where families owe zero taxes on their tax return, they can now receive the applicable tax credit amount in the form of an actual refund from the IRS to reimburse them for adoption-related expenses.  

Refundable tax credits are not common in our tax law because they basically provide a direct government subsidy that benefits taxpayers relatively quickly after they have incurred expenses for activities that the Congress wants to encourage — thus, a refundable tax credit is expensive for the government.  The Adoption Tax Credit that we have seen in the last 10 years has been a “non-refundable” tax credit – a factor that met with some criticism because it commonly allowed for more benefit to higher income taxpayers who had tax liabilities to offset with such a credit. The new change makes the tax benefits of the Adoption Tax Credit much more available to lower income families.

 The following scenario illustrates the changes to the Adoption Tax Credit law and how it will work:

 A family adopts a child and that family had an income prior to any tax credit such that they owe a total tax of $7,500.  They then calculated the costs incurred in their adoption and their total of allowed adoption expenses came to $10,000.   In this situation, the Adoption Tax Credit would not only zero out their tax liability of $7,500, but the IRS would also send this family a tax “refund” check for the left over $2,500 of the tax credit.

 Under the former law which established the Adoption Tax Credit as a non-refundable credit, this family’s tax liability would have been taken to zero, and the unused tax credit of $2,500 would not have been refunded, but would have been carried over to the next tax year to be applied to their tax liability in that year.     

 This is a very positive new tax law change for adoptive families.  Please do not hesitate to call my office or check with your accountant if you have any additional questions.

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