Adoption Tax Credit Guidance Released

The IRS issued interim guidance September 29 on the child adoption credit and income exclusion for employer reimbursements of adoption expenses, as expanded by the Patient Protection and Affordable Care Act (P.L. 111-148). For tax years beginning in 2010 and 2011, the act made the credit for qualified adoption expenses (QAEs) refundable rather than subject to the prior-year carryover for up to five years of credit amounts that exceeded an income phaseout. For both the credit and exclusion, it raised the maximum aggregate allowable amount per child in all tax years to $13,170, starting with 2010 tax years. The IRS outlined the latest guidance in a news release (IR 2010-100). In addition, the IRS released a draft revised Form 8839, Qualified Adoption Expenses, reflecting the law changes.

Carryforwards from Previous Tax Years

In Notice 2010-66, the IRS clarified how carryover amounts from pre-2010 tax years may be claimed in 2010. A credit amount claimed in a 2009 or earlier tax year and carried forward to a 2010 tax year is allowable as a refundable tax credit and is not subject to the income phaseout. Any additional credit amount claimed in 2010, however, is subject to the phaseout.

Substantiation Rules

The notice also instituted substantiation requirements for 2010 and following tax years for the credit or exclusion that differ according to whether the adoption is finalized in the United States or in a foreign country and, if the latter, whether the country is a party to the Hague Convention on Protection of Children and Co-operation in Respect of Intercountry Adoption (Hague Convention). For a domestic or foreign adoption that has been finalized in the United States, taxpayers must attach with their returns an adoption order or decree. For foreign adoptions finalized in a Hague Convention party country, taxpayers must attach a Hague Adoption Certificate, IH-3 visa or a foreign adoption decree translated into English. For countries not a party to the Hague Convention, substantiation may consist of a foreign adoption decree translated into English or an IR-2 or IR-3 visa.

For domestic adoptions not yet final, taxpayers may claim credit amounts in the tax year following that in which qualified adoption expenses were incurred. For such credit claims, taxpayers must attach any of six documents or other substantiating information specified in the notice.

For adoptions of special-needs children—for which taxpayers may be eligible for the full credit amount regardless of the amount of QAEs—in addition to the above documentation of finalization, taxpayers must also attach a state determination of special needs.

Taxpayers may redact “sensitive personal information” from an adoption order or special-needs assessment, but the IRS reserves the right to require a nonredacted copy if deemed necessary to substantiate the claim.

Safe Harbor for Finalized Foreign Adoptions

In Rev. Proc. 2010-31, effective September 29, 2010, the IRS provided a safe harbor for determining whether a foreign adoption has been finalized for purposes of claiming the adoption credit or exclusion. For adoptions within the scope of the revenue procedure and finalized in a Hague Convention party country, the IRS will not challenge taxpayers’ treatment of an adoption as finalized in the tax year in which the country issues a final decree of adoption or the U.S. Secretary of State issues a certificate under the Intercountry Adoption Act of 2000 (IAA). For adoptions from foreign countries subject to the IAA but finalized in the United States, the IRS will accept as the finalization date that in which a state court enters a final adoption decree.

Adoptions from non-Hague Convention party countries remain subject to rules of Rev. Proc. 2005-31.

Modification of Rev. Proc. 2009-50

Rev. Proc. 2010-35 modifies Rev. Proc. 2009-50 to reflect the increases in the maximum credit amount and the phaseout amounts for the adoption credit and the maximum excludible amount and the phaseout amounts for payments received from an adoption-assistance program.