Guidance On Expanded Adoption Credit Reflects New Law And Provides Foreign Adoption Safe Harbors

Rev Proc 2010-31, 2010-40 IRB; Rev Proc 2010-35, 2010-42 IRB; Notice 2010-66, 2010-42 IRB; IR 2010-100

IRS has issued guidance reflecting recent statutory changes made to the adoption credit and the exclusion for employer-provided adoption assistance, and providing safe harbors for determining the finality of foreign adoptions for purposes of the credit and the exclusion. In addition, IRS has issued interim guidance on computing the newly refundable adoption credit, and substantiating claims for the credit.

Background. An individual can claim a tax credit for qualified adoption expenses which are reasonable and necessary adoption fees, court costs, attorney fees, and other expenses that are directly related to and the principal purpose of which is the taxpayer's legal adoption of an eligible child. For tax years beginning in 2010, under Code Sec. 36C(a)(3), the credit allowed for an adoption of a child with special needs is $13,170. For tax years beginning in 2010, under Code Sec. 36C(b)(1), the maximum credit allowed for other adoptions is the amount of qualified adoption expenses up to $13,170. The available adoption credit begins to phase out under Code Sec. 36C(b)(2)(A) for taxpayers with modified adjusted gross income in excess of $182,520 and is completely phased out for taxpayers with modified adjusted gross income of $222,520 or more. The adoption credit maximum dollar limit and phaseout are adjusted for inflation in tax years beginning after Dec. 31, 2010.

Under Code Sec. 137, an employee may exclude amounts paid or expenses incurred by his employer for qualified adoption expenses connected with the employee's adoption of a child under an adoption assistance program. Similar maximums and phaseout thresholds apply for the employer-provided adoption assistance exclusion as for the adoption credit (discussed above).

Prior to amendment under Patient Protection and Affordable Care Act (P.L. 111-148), the credit was not refundable. Former § 23(c) allowed a taxpayer to carry forward the amount of the credit in excess of the taxpayer's tax liability to five subsequent tax years. The income limitation did not apply to an amount carried forward to a later tax year.

If an adoption is not final in the tax year a taxpayer pays or incurs the expenses, the credit is allowed for those expenses in the next tax year. For qualified adoption expenses paid or incurred during or after the tax year in which the adoption is final, the credit is allowed in the tax year in which the qualified adoption expenses are paid or incurred. For foreign adoptions, the credit is allowed only if the adoption becomes final and qualified adoption expenses paid or incurred in any tax year before the tax year in which the adoption becomes final are treated as paid or incurred in the tax year in which the adoption becomes final.

Rev Proc 2005-31, 2005-1 CB 1374, provides guidance to taxpayers on the finality of foreign adoptions but does not apply to adoptions governed by the Hague Convention on Protection of Children and Co-operation in Respect of Intercountry Adoption (Convention) and subject to the Intercountry Adoption Act of 2000, P.L. 106-279 (Convention adoptions). The Convention became effective in the U.S. on Apr. 1, 2008.

Code Sec. 36C(f)(2)(B) authorizes IRS to require taxpayers to provide information substantiating claims for the adoption credit.

Revenue Procedure updated to reflect new law. Rev Proc 2010-35 reflects the statutory changes made to the adoption credit under Code Sec. 36C (formerly Code Sec. 23), namely, an increase in the amount of adoption credit to $13,170 and adjustment to the phase-out (discussed above) and the increase in the exclusion for employer-provided adoption assistance and phase-out (discussed above). Rev Proc 2010-35 has also been amended to reflect the increase in the Code Sec. 137 exclusion for employer-provided adoption assistance and phase-out (discussed above).

IRS has also announced that it has released a draft version of the form that eligible taxpayers will use to claim the newly-expanded adoption credit on 2010 tax returns filed next year. (IR 2010-100)

Safe harbors for determining finality of foreign adoptions. Rev Proc 2010-31 applies to taxpayers who claim the adoption credit or exclusion for qualified adoption expenses paid or incurred for a Convention adoption of a child who is not a U.S. citizen or U.S. resident at the time the adoption process commences and who is immigrating to the U.S.

Under this guidance, IRS will not challenge the taxpayer's treatment of an adoption that is finalized in another country (sending country) as final in the tax year that either: (1) the sending country enters a final decree of adoption, or (2) the Secretary of State issues a certificate under § 301(a) of the IAA. In addition, IRS will not challenge the taxpayer's treatment of an adoption of a child who has entered the U.S. for the purpose of adoption subject to § 301(c) of the IAA as final in the tax year that a state court enters a final decree of adoption.

Rev Proc 2010-31 is effective Sept. 29, 2010. A taxpayer may file an amended return to claim the adoption credit for qualified adoption expenses paid in tax year 2008 or 2009, if the period of limitation under Code Sec. 6511 has not expired, for a Convention adoption that became final under this revenue procedure during the period beginning on Apr. 1, 2008 and ending on Dec. 31, 2009.

Interim guidance for computing adoption credit and substantiating claims. Notice 2010-66 provides that an amount of an adoption credit claimed in an earlier tax year that a taxpayer carries forward to a tax year beginning in 2010 is allowable as a refundable tax credit. An amount that a taxpayer carries forward to a tax year beginning in 2010 is not subject to an income limitation in that tax year.

Illustration 1: In 2008, taxpayer pays $2,000 of qualified adoption expense to adopt an eligible child who is a U.S. citizen. In 2009, taxpayer pays an additional $8,000 of qualified addition expenses and the adoption becomes final. The adoption credit for $10,000 is allowed in 2009.

Taxpayer's tax liability for tax year 2009 is $6,000, and taxpayer applies $6,000 of the $10,000 credit against taxpayer's 2009 tax liability. Taxpayer carries forward $4,000 of the credit to 2010.

In 2010, taxpayer's tax liability is $3,000. Taxpayer applies $3,000 of the $4,000 carried forward adoption credit against taxpayer's 2010 tax liability. Taxpayer is entitled to a refund of the remaining credit.

Illustration 2: The facts are the same as in the above example, except that in 2010, taxpayer pays an additional $2,000 of qualified adoption expenses. Taxpayer's income exceeds the upper income limitation for 2010. Because of the income limitation, the adoption credit is not allowable for the $2,000 of qualified adoption expenses taxpayer pays in 2010. However, taxpayer may apply the $4,000 adoption credit carried forward to reduce taxpayer's tax liability for 2010 and may receive a refund of any carried forward credit that exceeds taxpayer's tax liability.

Substantial requirements. Notice 2010-66 provides that a taxpayer must provide a copy (unless otherwise specified) of the applicable documents described in paragraph (a) or (b) below to substantiate the taxpayer's adoption or attempted adoption of an eligible child. A taxpayer also must comply with paragraph (c) below for a special needs adoption. The taxpayer attaches the document(s) to the taxpayer's income tax return for the tax year that the taxpayer claims the credit, beginning after Dec. 31, 2009.

a. Domestic and foreign adoptions that have been finalized.

1. For a domestic or foreign adoption finalized in the U.S., an adoption order or decree.

2. For a foreign adoption governed by the Hague Convention and finalized in another country: (A) A Hague Adoption Certificate (Immigrating Child), (B) An IH-3 visa, or (C) A foreign adoption decree, translated into English.

3. For a foreign adoption from a country that is not party to the Hague Convention: (A) A foreign adoption decree, translated into English, or (B) An IR-2 or IR-3 visa.

b. Domestic adoptions that are not final.

1. An adoption taxpayer identification number, obtained by the taxpayer for the child, included on the taxpayer's income tax return (instead of attaching a document),

2. A home study completed by an authorized placement agency,

3. A placement agreement with an authorized placement agency,

4. A document signed by a hospital official authorizing the release of a newborn child from the hospital to the taxpayer for legal adoption,

5. A court document ordering or approving the placement of a child with the taxpayer for legal adoption, or

6. An original affidavit or notarized statement signed under penalties of perjury from an adoption attorney, government official, or other person, stating that the signor: (A) Placed or is placing a child with the taxpayer for legal adoption, or (B) Is facilitating the adoption process for the taxpayer in an official capacity, summarizing the facilitation.

c. Adoptions of special needs children. In addition to the documentation required under paragraph (a) above, a taxpayer claiming the adoption credit for a child with special needs must attach a copy of the state determination of special needs to the taxpayer's income tax return for the tax year that the taxpayer claims the adoption credit for a child with special needs.

An order or decree must include information that establishes that the taxpayer's adoption of the eligible child has been finalized and the date finalized, and a special needs determination must include information that establishes that the state has made a determination of special needs for the eligible child. A taxpayer may redact sensitive personal information from an adoption order or decree or a special needs determination. However, IRS may require the taxpayer to provide an unredacted copy of the document if needed to substantiate the claim for the credit.

This notice is effective for tax years beginning after Dec. 31, 2009.

References: For the adoption credit, see FTC 2d/FIN ¶A-4400 et seq.; United States Tax Reporter ¶234; United States Tax Reporter ¶36C4; TaxDesk ¶569,500 et seq.; TG ¶1320 et seq.; For the employer adoption assistance exclusion, see FTC 2d/FIN ¶H-1450 et seq.; United States Tax Reporter ¶1374; United States Tax Reporter ¶36C4; TaxDesk ¶133,600 et seq.; TG ¶7252 et seq.