After the historic June 26, 2013, Supreme Court ruling that Section 3 of the Defense of Marriage Act (aka DOMA) was unconstitutional, many LGBT couples happily committed to legal marriage in 2013 and even more are considering nuptials in the near future. However, many couples, for a variety of reasons, have not yet taken the plunge. Our LGBT tax consulting experts have identified several economic and tax considerations LGBT couples may want to quantify when assessing the financial impact of marriage. This is the second post, in a series of blogs, that addresses these issues. Last week, we began the series with a post that about who should claim the kids when a couple isn’t married.
No individual blog in this series should be viewed singularly as there are many variables that would impact a couple’s decision to get married, and many of these issues are intertwined. To discuss your specific situation, call on us and someone from our dedicated LGBT services team will contact you.
Today, we address the adoption tax credit, and why waiting until after the adoption of a child to get married could save you significant tax dollars.
In general, there are two tax benefits that coincide with the adoption of a child. That’s right - for all of the bumps, bruises, sleep deprivation and last-minute homework assignments you commit yourself to, the IRS has afforded adoptive parents two mutually exclusive tax benefits. These are:
1. The Adoption Credit
This provision allows parents to claim a nonrefundable credit against their federal income tax for up to $12,970 in 2013 ($13,190 in 2014) for the "qualified adoption expenses" paid for each adopted child. It's a dollar-for-dollar reduction of tax; however, the adoption credit is NOT refundable. In other words, the credit can only be claimed up to the amount of your tax liability.
2. The Adoption Benefit Exclusion
Adoptive parents may be able to exclude up to $12,970 in 2013 ($13,190 in 2014) of “qualified adoption expenses” (QAEs) paid by an employer under an adoption assistance program from gross income. Expenses paid by an employer cannot also qualify for the adoption credit.
For same-sex couples considering both adoption and marriage, there are two scenarios in which finalizing the adoption during the calendar year BEFORE the marriage could cause the adoption credit/exclusion to yield potentially significant tax savings. This could pay for a few additional nights on the honeymoon!
Delaying the marriage until the calendar year AFTER the adoption is finalized should be considered if:
- One partner is considering adopting the other partner’s child (aka second-parent adoption)
- Both partners have combined income over $195,000
For situation #1, since QAEs do not include expenses connected with the adoption of a child of a taxpayer's spouse, once married, a partner cannot claim either of the above two benefits for expenses paid in connection with the adoption. However, if you adopt you partner’s child before the marriage, the partner is not considered your “spouse,” and the adoption credit/exclusion will be available.
For situation #2, there are a few things at play. First, the maximum allowable adoption credit/exclusion begins to reduce (phase-out) for taxpayers with adjusted gross income (AGI) over $194,580 (at $234,580 of AGI the credit/exclusion is completely phased-out and cannot be taken). Unlike most items in the tax code, this phase-out does not increase for taxpayers who file as married. Additionally, the adoption credit/exclusion allows unmarried taxpayers to shift the credit/exclusion between their individual returns however the two partners agree (regardless of which partner actually paid the expenses). Thus, for higher-earning couples or couples with disparate income, remaining unmarried allows for more flexibility in claiming credit/exclusion.
Consider this example: John Doe and Don Jo are considering getting married and adopting a child in 2014. They each make $185,000 and have incurred a combined $12,500 of expenses in connection with the adoption. If John and Don take their vows in the same calendar year as finalizing the adoption (or before), they will completely phase-out of the adoption credit when they file their 2014 joint tax return. If however, John and Don become fathers before their marriage they will be able to take a credit for the entire $12,500 of adoption expenses they paid since each would individually fall below the phase-out limit (we also assume John and Don would have a combined federal tax liability of at least $12,500). By finalizing the adoption the calendar year before getting married, John and Don save $12,500 in taxes and have an incredibly cute ring-bearer or flower girl for their wedding.
IMPORTANT NOTE: Couples considering marriage for the calendar year after the adoption is finalized should be sure to pay any QAEs before the end of the calendar year in which the adoption is finalized!
Below is additional information regarding the Adoption Credit and Adoption Benefit Exclusion that you should familiarize yourself with if you are considering adoption.
Qualified Adoption Expenses (QAEs)
QAEs are the reasonable and necessary adoption fees, court costs, attorney fees, traveling expenses, and other expenses directly related to the legal adoption of an "eligible child.” QAE’s do not include expenses connected with the adoption of a child of a taxpayer's spouse or expenses of carrying out a surrogate parenting arrangement. You may not claim both a credit and exclusion for the same expense. Expenses that are reimbursed by an employer do not qualify for the credit, but benefits provided by an employer under an adoption assistance program may qualify for the exclusion.
Generally, an "eligible child" is a child under the age of 18 at the time the QAE is paid. A child who turned 18 during the year is an eligible child for the part of the year he or she is under age 18.
When to Claim the Credit or Take the Exclusion
If QAEs are paid before the year the adoption becomes final, the credit is claimed for the year after the one in which the expenses are paid. If the expenses are paid in the year the adoption becomes final or in a later year, the credit is claimed for the year in which the expenses are paid. Employer-provided adoption benefits are excludable from the employee's gross income for the year in which the employer pays the QAE.
How to Claim the Credit or Take the Exclusion for QAEs
Adoptive parents who paid qualified adoption expenses or who received employer-provided adoption benefits must use Form 8839 to compute the amount of the credit and the amount of benefits that may be excluded from their gross income.
When using Form 8839 – Qualified Adoption Expenses you cannot file your tax return electronically despite the fact that there is no longer a requirement to attach the adoption documentation with your tax return. However, documentation must be kept as part of your records.
If you are legally married and your filing status is married filing separately in the year when particular QAEs are first allowable, you are ineligible to claim the credit or exclusion for the particular expenses unless you amend your return to change your filing status to married filing jointly.
We strongly recommend consulting with a reputable LGBT family law attorney and tax advisor to evaluate the legal and financial impact of marriage and adoption on your family. You can use our LGBT Tax Consulting & Financial Planning webpage as a resource to help you and your partner/spouse make important decisions regarding your family finances. If you would like to discuss your specific situation, call on us and someone from our dedicated LGBT services team will contact you.