Planning for Adoption Finances

November is National Adoption Month

The decision to adopt a child is a profound and rewarding journey that transforms lives. But it’s not just a personal journey—it can also be a financial one. To support adoptive families, the U.S. government offers both an Adoption Tax Credit and Qualified Birth or Adoption Distributions (QBOAD), which can provide significant financial relief during the adoption process. In this blog post, we will delve into the details of the Adoption Tax Credit and QBOAD, how they work, and how you can maximize their benefits to make your adoption journey more manageable.

Understanding the Adoption Tax Credit

The Adoption Tax Credit is a financial incentive provided by the federal government to help offset the costs associated with adoption. While it won’t cover all expenses, it can significantly reduce the financial burden of adoption.

Eligibility: To qualify for the Adoption Tax Credit, you must adopt an eligible child (usually under the age of 18) and incur eligible adoption expenses. Your income and tax liability may affect the amount of the credit you can claim.

Eligible Adoption Expenses:

• Qualifying adoption expenses may include agency fees, court costs, attorney fees, travel, and other necessary expenses directly related to the adoption.
• It’s essential to keep detailed records of your expenses to substantiate your claim.

Maximizing the Adoption Tax Credit

To make the most of the Adoption Tax Credit, consider these strategies:

Consult with a Tax Professional: Adoption tax laws can be complex, and a tax professional can help you navigate the process, ensuring you claim all eligible expenses and receive the maximum credit.

Claiming the Credit: File IRS Form 8839 to claim the Adoption Tax Credit, providing the necessary documentation and proof of expenses. Keep in mind that the credit is non-refundable, meaning it can reduce your tax liability to $0, but you won’t receive a cash refund if the credit exceeds your tax liability.

Special Rules: There are specific rules for adopting a child with special needs that may allow you to claim the full credit even if you did not incur qualifying expenses.

Understanding Qualified Birth or Adoption Distributions

The 2019 Secure Every Community Up for Retirement Enhancement (SECURE) Act provided employers with the flexibility to permit employees to withdraw funds from their 401(k) retirement accounts to assist in covering expenses related to childbirth or adoption. Effective January 1, 2020, retirement plans have the authority to authorize qualified birth or adoption distributions (QBOADs). A QBOAD can be taken from any “eligible retirement plan” excluding defined benefit plans. Employees can initiate a QBOAD within the twelve-month window following the official adoption of a child.

QBOADs are capped at $5,000 per person for each instance of birth or adoption. This restriction is applicable to all plans in which the employee is enrolled, including those within the employer’s corporate network, plans with other employers where the employee has assets, and any individual retirement account (IRA) maintained by the employee. It’s worth noting that the $5,000 limit pertains to an individual, not a family. Consequently, the employee’s spouse may also receive a separate QBOAD of up to $5,000 for the same adoption, even if both spouses are employed within the same corporate network. Additionally, the $5,000 limit is applicable per child. If an employee adopts twins, they can request two separate QBOADs, totaling up to $10,000.

Note: QBOADs do not fall under the 20% mandatory withholding requirement that is imposed on eligible rollover distributions. Instead, QBOADs adhere to the standard tax withholding regulations for lump sum payments that do not qualify as eligible rollover distributions. This typically involves a mandatory 10% withholding, unless the employee chooses not to have any withholding.

The Adoption Tax Credit and QBOADs are valuable resources for families on an adoption journey, helping to ease the financial strain associated with the process. While they may not cover all adoption expenses, understanding the eligibility criteria and following best practices can provide much-needed financial relief.