Wednesday, April 20, 2011

Adopt a Child - Get a Big Check from the IRS

The federal tax code contains a provision that provides a tax credit (reduction in tax liability) for people who adopt a child. This is one of those tax code provisions meant to affect social behavior.

Taxpayers who incur expenses to adopt a child can take a dollar for dollar tax credit up to a maximum amount of $13,170 for 2009. This is adjusted for inflation each year. So that high income taxpayers do not benefit from this credit, there is an income phase out, such that generally taxpayers with Adjusted Gross Income over about $222,000 cannot take the credit. They can, however, carry forward any un-allowed credit for up to five years in case they have a future year with lower income.

This credit has been a non-refundable credit. That means, if allowed, it cannot lower tax liability below zero – it cannot be refunded to the taxpayer if they do not have a tax liability. We’re not talking refund or balance due here, just tax liability before applying any withholding. It does, however, still carry over for a future year when they might have a tax liability to offset.

Now, adoption is a good thing and it should be encouraged. It can be argued that the adoption credit is good for our society even if it reduces government revenues.

So, as part of Obamacare passed by your Congress and your President, the adoption credit was extended through the end of 2011. You might ask why when there were revenue generating needs in Obamacare. But wait, it gets better for you head scratchers. The new law allowed this credit to be refunded. So, even if you don’t owe any tax you get the money – a check in the mail. And remember that you can carry over from five years ago? Yes, indeed, taxpayers that never expected to get the credit but adopted anyway now get a windfall. These people had already adopted. Can you imagine the surprise of a taxpayer who had adopted – oh, let’s say five children in the past five years. They are median income and they look at their refund and see a refund of about $65,000. Don’t forget, they have already spent the money for the adoption and never expected to get any tax credit.

But you ask, if it is meant to affect social behavior, why did they make this refundable part applicable to the carryover part? You figure that out because I am still scratching my head. Oh, and if you think this cannot happen, I have seen tax returns with enormous adoption credit refunds. How much is this adding to the deficit?