3.6 Adoption Benefits

If your employer pays or reimburses you in 2012 for qualifying adoption expenses under a written, nondiscriminatory plan, up to $12,650 per qualifying child may be tax free. Employer-provided adoption assistance may be for any child under age 18, or a person physically or mentally incapable of self-care. The exclusion applies to adoption fees, attorney fees, court costs, travel expenses, and other expenses directly related to a legal adoption. Expenses for adopting your spouse’s child and the costs of a surrogate-parenting arrangement do not qualify. If you have other qualifying adoption expenses, you may also be able to claim a tax credit up to a separate $12,650 limit; both the exclusion and the credit may be claimed for the same adoption if they are not for the same expenses. The exclusion and the credit are subject to similar limitations, including a phaseout based on income. See Chapter 25 for a full discussion of the credit.

Filing Tip

Claiming Credit and Exclusion

If you paid adoption expenses in 2012 that were not reimbursed by your employer, and the adoption was final in 2012, you may be able to claim the adoption credit; see Chapter 25.

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The full $12,650 exclusion limit is available for the adoption of a “special needs” child even if actual adoption expenses are less than $12,650. A “special needs” designation is made when a state determines that adoption assistance is required to place a child (U.S. citizen or resident) with adoptive parents because of special factors, such as the child’s physical condition or ethnicity.

If you are adopting a child who is not a U.S. citizen or resident when the adoption effort begins, the exclusion is available only in the year the adoption becomes final. For example, if in 2012 your employer pays for expenses of adopting a foreign child but the adoption has not become final by the end of the year, you must report the employer’s payment as wage income for 2012. You will claim the exclusion on Form 8839 in the year the adoption is final.

Reporting employer benefits and claiming the exclusion on your 2011 return.

You must file Form 8839 to report your employer’s payments and to figure the tax-free and taxable portions of the benefits. The employer’s payments will be included in Box 12 of Form W-2 (Code T). This total includes pre-tax salary reduction contributions that you made to a cafeteria plan (3.14) to cover such expenses.

If you are married, you generally must file a joint return to exclude the benefits as income. However, if you are legally separated or if you lived apart from your spouse for the last six months of the year, the exclusion may be available on a separate return; see Form 8839 for details.

On 2012 tax returns, the allowable exclusion is phased out if your modified adjusted gross income (MAGI) is between $189,710 and $229,710 (including the employer’s adoption assistance and adding back certain tax-free income from foreign sources). Figure the tax-free amount on Form 8839. If your modified adjusted income for 2012 is $229,710 or more, employer-paid adoption expenses are fully taxable.