Key Elements of the U.S. Tax System

Credit Amount

Taxpayers can receive a tax credit for all qualifying adoption expenses up to $13,570 in 2017. The maximum credit is indexed for inflation. Taxpayers may also exclude from income qualified adoption expenses that are paid or reimbursed by an employer, up to the same limit as the credit. Taxpayers can use the tax credit and the income exclusion but cannot claim the same expenses for both.

“Special needs” adoptions automatically qualify for the maximum credit regardless of actual out-of-pocket expenses. For purposes of the credit, a child has special needs if a state’s welfare agency determines that the child cannot or should not be returned to his or her parents’ home and that the child probably will not be adoptable without assistance provided to the adoptive family. This provision is designed 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 public foster care program).

Eligibility

The adoption credit is available to most adoptive parents, with some exceptions. The credit is not available to taxpayers whose income exceeds certain thresholds. The thresholds are indexed for inflation. In 2017 the credit begins to phase out at $203,540 of modified adjusted gross income and phases out entirely at income of $243,540. The credit also is not available for adoptions of stepchildren.

Refundability

The adoption tax credit is nonrefundable but can be carried forward for up to five years. The credit is thus of little or no value to low-income families who pay little or no income tax over a period of years. The Patient Protection and Affordable Care Act of 2010 made the adoption tax credit refundable for 2010 and 2011. Concerned about the potential for fraud, the Internal Revenue Service (IRS) stepped up compliance efforts. The result, according to the National Taxpayer Advocate, 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 20 percent of those savings were spent on interest owed to taxpayers with delayed refunds. The credit reverted to nonrefundability in 2012.

Tax Expenditure

The credit has been repeatedly expanded, from an initial maximum value of $5,000 in 1997 to $13,570 in 2017. In fiscal year 2015, credit claims reduced tax liability by $300 million, according to the US Department of Treasury (figure 1). The temporary availability of a refundable credit pushed the tax expenditure up to the dramatically higher figures of $1.6 billion in 2010 and $2.35 billion in 2011 (including the refundable portion).

Who Gets It

The distribution of the credit across income groups ranges from small amounts for low- and moderate-income households (because of their minimal tax liability and the credit’s non-refundability) and the highest-income households (because of the income cap) to substantial amounts to those with upper-middle incomes. For example, in 2014, the credit for those with incomes between $50,000 and $75,000 (almost 30 percent of claimants) averaged $2,529 per adoption, while the average credit for households with incomes between $100,000 and $200,000 (about 36 percent of claimants) was $8,015 per adoption (table 1).

The most recent year with data available by adoption type (2004) indicates that nearly half of adoptions for which the credit was claimed were for domestic children without special needs, with only 18 percent classified as special needs and the remainder reflecting international adoptions.