Tax Tip for October 2002
Adoption
tax credit and exclusion for qualified adoption expenses
Two tax benefits
are available to offset the expenses of adopting a child. Adoptive parents may
be able to claim a credit against their federal tax for up to $10,000 of
“qualified adoption expenses” (see below) for each adopted child. That's a
dollar-for-dollar reduction of tax. Also, adoptive parents may be able to
exclude from their gross income up to $10,000 of qualified adoption expenses
paid by an employer under an adoption assistance program. Both the credit and
the exclusion are reduced (phased out) if the parents' income exceeds certain
limits (see discussion below).
Adoptive parents
may claim both a credit and an exclusion for expenses of adopting a child. But
they may not claim both a credit and an exclusion for the same expense.
Qualified
adoption expenses. To qualify
for the credit or the exclusion, the expenses must be “qualified adoption
expenses.” These are the reasonable and necessary adoption fees, court costs,
attorney fees, traveling expenses (including amounts spent for meals and
lodging) while away from home, and other expenses directly related to the legal
adoption of an “eligible child” (defined below).
Qualified adoption
expenses don't include expenses connected with the adoption of a child of a
taxpayer's spouse, expenses of carrying out a surrogate parenting arrangement,
expenses that violate state or federal law, or expenses paid using funds
received from a federal, state, or local program. Expenses that are reimbursed
by an employer don't qualify for the credit, but benefits provided by an
employer under an adoption assistance program may qualify for the exclusion.
Expenses in
connection with an unsuccessful attempt to adopt an eligible child before
successfully finalizing the adoption of another child can qualify. Expenses
connected with a foreign adoption (i.e., one in which the child isn't a U.S.
citizen or resident) can only qualify if the child is actually adopted.
Starting in 2003,
taxpayers who adopt a child with special needs will be deemed to have qualified
adoption expenses in the tax year in which the adoption becomes final in an
amount sufficient to bring their total aggregate expenses for the adoption up to
$10,000. They can take the adoption credit or exclude employer-provided adoption
assistance up to that amount, whether or not they had $10,000 of actual
expenses.
Eligible
child. An “eligible child”
is a child under the age of 18 at the time the qualified adoption expense is
paid. If the child turned 18 during the year, the child is an eligible child for
the part of the year he or she is under age 18. A person who is physically or
mentally incapable of caring for himself is also eligible, regardless of age.
Special
needs child. This refers to a
child who the state has determined cannot or should not be returned to his
parents and who can't be reasonably placed with adoptive parents without
assistance because of a specific factor or condition, e.g., ethnic background,
age, membership in a minority group, medical condition, or handicap. Only a
child who is a citizen or resident of the U.S. can qualify as having special
needs.
When to
claim the credit or take the exclusion.
If the qualifying expenses 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. For
example, say $2,000 was paid in 2000, $1,000 in 2001, and $3,000 in 2002, when
the adoption becomes final. The taxpayer claims a $2,000 credit in 2001 (for the
2000 expenses). The $1,000 of 2001 expenses and the $3,000 of 2002 expenses are
combined to be claimed in 2002.
Employer-provided
adoption benefits are excludable from the employee's gross income for the year
in which the employer pays the qualified adoption expense.
In the case of a
foreign adoption, neither the credit nor the exclusion may be taken until the
year in which the adoption becomes final.
Phase-out
for high income taxpayers. The
credit allowable for any year is phased out for taxpayers with adjusted gross
income (AGI) over $150,000 and is eliminated when AGI reaches $190,000. The
credit is reduced by a percentage equal to the excess of AGI over $150,000
divided by $40,000. For example, say taxpayers who could otherwise claim a
$2,000 credit have an AGI of $160,000. Their $160,000 AGI minus $150,000 equals
$10,000, and $10,000 divided by $40,000 is 25%. Accordingly, the taxpayers
“lose” 25% of their credit ($2,000 times 25% is $500) and can only claim a
credit of $1,500. (Special rules for determining AGI apply in some cases.) The
phase-out rules for high-AGI taxpayers apply for the exclusion as well.
How to
claim the credit or take the exclusion for qualified adoption expenses.
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.
Child's
taxpayer identification number required for credit or exclusion.
IRS can disallow the credit and the exclusion if a valid taxpayer identification
number (TIN) for the child is not included on the return. Taxpayers may obtain
what is in effect a temporary identification number for a child they are in the
process of adopting. This form of TIN, called an adoption taxpayer
identification number (ATIN), enables the adoptive parents to claim the credit
and exclusion for qualified adoption expenses. Form W-7A is used to get an ATIN.
When the adoption becomes final, the adoptive parents must apply for a social
security number for the child and, once obtained, the social security number,
rather than the ATIN, must be used.
If you have
recently adopted a child, are in the process of adopting a child, or are
thinking of adopting a child, we can help you to make sure that you get the full
benefit of the substantial tax savings the adoption credit and the exclusion
offer. Please call if you have any questions. We look forward to discussing
these tax benefits with you.
Did
you use your car partially for business, partially for personal use?
The rules are more complicated in this situation, which can occur if you are
self-employed, or an employee required to supply a car for business use.
·
If you sell the
part-business, part-personal-use car, cost and depreciation must be allocated
between the business and personal portions. Gain or loss on the business part is
recognized; gain, but not loss, is recognized on the personal part.
·
If you trade in
the part-business, part-personal-use car, a special basis rule applies for
depreciation purposes only: The basis of the new car as computed under the
normal trade-in rules is reduced by any difference between (1) the depreciation
that would have been allowable had the old car been used 100% for business
driving, and (2) the depreciation claimed for its actual business use.
Are
you thinking of leasing a business car?
The complex rules that apply to purchased business autos are one reason many
businesses are leasing autos instead of buying them. You simply deduct the
business/investment use portion of annual lease costs, and, if the auto is a
“luxury” model (for example, if the lease began during 1999, 2000, 2001, or
2002, and the auto's fair market value exceeds $15,500), you add back to income
during each lease year an IRS-table-derived income inclusion amount. There are,
however, a few special angles you should be aware of:
·
If you trade in
a car in exchange for a lower lease price on a new car, the transaction won't be
a tax-free like-kind swap, so any realized gain or loss will be recognized under
the rules that apply to a sale.
·
If you pay an
additional sum up-front, it should be amortized over the life of the lease.
·
Any refundable
deposit required as part of the lease deal can't be deducted at all.
All
of this sounds very complicated, and it is. Before you sell or trade in your
business car or lease a new one, please give us a call and we'll set up a
meeting to discuss the options.
