Tax Center / Marriage & Family
Adoption Expense Credits, Part III
Employer Assistance
By Roy Lewis
In Parts I and II of this series, we gave you an overview of the Adoption Credit, how it works, and who is qualified and eligible. But, it gets even better. In this installment, we look at a method by which your employer can help you with your adoption... tax free.
The Adoption Assistance Exclusion
In addition to the Adoption Credit, there is another twist in the law. Your gross income (assuming that you are a W-2 type employee) does not include amounts your employer pays or incurs for your qualified adoption expenses through an adoption assistance program it has established. But, as with the Adoption Credit, this income exclusion is effective for tax years beginning after December 31, 1996, and does not apply to amounts paid after December 31, 2001.
Since the adoption assistance exclusion is based on a formal plan established by your employer, we'll not spend too much time with it here. Just know that there are income limitations and restrictions on the adoption exclusion similar to the Adoption Credit. Make sure to check with your Human Resources department to see if your employer offers such an adoption assistance program. In most cases, if your employer does maintain such a program, you would be financially better off using the employer program rather than the Adoption Credit. So check it out, Fool.
Coordination of Benefits
The Adoption Credit and the adoption assistance exclusion are coordinated, so you can claim both in relation to one adoption effort, but you cannot claim both for the same expense.
If you are within the AGI limitations, you can claim the $5,000 credit for qualified adoption expenses and exclude from income another $5,000 paid by your employer for other qualified adoption expenses. But, you can't claim the credit for amounts paid by your employer even if the payment is not made under a qualified adoption assistance program.
And, you also can't exclude from income amounts that you pay yourself. If you pay the expenses yourself, you are only eligible for the credit. The combination of both the credit and the exclusion can be a valuable tool when adoption expenses are substantial.
Example: Let's take the case of William and Mary. They paid out-of-pocket qualified adoption expenses of $4,000 in 1999. In addition, William's employer has a qualified adoption assistance program and pays $6,000 of qualified adoption expenses directly. William will be able to exclude $5,000 of this assistance from his income. Heck, it doesn't even show up on his W-2 as wages. It's just completely ignored for tax purposes. William will have to claim as income the "excess" employer assistance payment of $1,000... but that's still a good deal. And, it gets better. Remember that $4,000 William and Mary paid out-of-pocket for additional qualified adoption expenses? Those expenses are eligible for the Adoption Credit. Sweet.
So, if adoption is in your future, make sure you understand how the law works and what is available to you. You can learn more about the rules by looking at IRS Form 8839 and the associated instructions. But, if you really want to get into the meat of the adoption rules, you should add Publication 968 to your required reading list.
