Sunday, October 28, 2007

$$$ FREE ADOPTION MONEY $$$

How You Can Afford To Adopt
(written by Angel's husband Russ)

I know. I know. I know. Husbands are to be seen and not heard, but I enter the blogosphere bearing good news to many who fear the cost of adoption. So many times when people inquire about our adoption, they express their desire to adopt as well as their doubts that they could ever cover the cost. As such, Angel has asked me to lay out how almost everyone has access to at least $13,000 – $18,500 to cover adoption costs – FREE MONEY! Also, I’ll talk about how to get as much of that money up front to minimize any need to take on debt.

First of all…what do I know about this stuff? In addition to having gone through the adoption process, I have a background of tax planning and high net worth investment planning with Deloitte & Touché. That said, I must add the disclaimer that I have been out of the business for a while (4+ years) and before employing any ideas I write here, I would encourage you to speak to a current tax professional.

I’ve done my best to simplify this as much as possible, but it can get pretty complex in some cases. Please feel free to email us with any questions you have.

Boring stuff aside, let’s get to the good stuff.

Tax Credit vs. Tax Deduction:
First, let’s discuss the difference between a tax credit and a tax deduction because this causes confusion for a number of people and its important to understand this before we go any further. The most important note is that a tax credit is more beneficial as it reduces your tax liability dollar for dollar.

A tax deduction (e.g. mortgage interest) reduces your taxable income. In other words, someone who had taxable income $50,000 and had tax rate of 15%, they would pay $7,500 in taxes. If they had a $10,000 deduction, their taxable income would go to only $40,000 and their taxes would go to $6,000 (15% of $40,000). They would save $1,500 in taxes.

If they had received a tax credit instead of a deduction, they would have still had $50,000 of taxable income creating a tax liability of $7,500; however, the tax credit would reduce their tax liability dollar for dollar to where they would receive a $2,500 refund rather than paying taxes.

Question #1: Where does this money come from?
Answer:
Your taxes and your company. Let’s break it down.

Source #1: Adoption Tax Credit ($11,000)
In 2007, the current tax laws will allow you to be fully reimbursed for up to 10,960 of qualified adoption related costs (most of you adoption costs are qualified) through the Adoption Tax Credit. A tax credit is more beneficial than a tax deduction. This credit is allowed in the year that the adoption is finalized, but can be limited for high income families ($165,000+).
Any expenses reimbursed by your employer do not qualify for the credit; however, most international adoptions will cost more than the Adoption Tax Credit and any employer reimbursement together so you will be able to receive both in full. See example #6 below for scenario where adoption costs are lower than the total of the employer reimbursement and Adoption Tax credit.

Source #2: Child Tax Credit ($1,000)
For each child, the current tax laws allow you to take another tax credit of up to $1,000 per child. This tax credit is not related to the adoption, but instead to the fact that you have a new child in your home. You can take this credit every year the child is a dependent in your home. This tax credit starts being reduced if your AGI (basically your income less retirement plan contributions, health insurance and student loan interest and a few other deductible items) exceeds $110,000 for families.

Source #3: Personal Exemption (appx. $825)
You receive a tax deduction (different from the tax credits we have shown above) of $3,300 for each person in your family. If you are in the 25% tax bracket, then your taxes would go down by $825 (25% of $3,300). To see which tax bracket you are in, find your taxable income off of last year’s tax return and compare to the table below.

Tax Bracket Taxable Income
10% 0 - 15,650
15% 15,650 - 63,700
25% 63,700 - 128,500
28% 128,500 - 195,850
33% 195,850 - 349,700
35% 349,700 and Up

Source #4: Charitable Deduction (appx. $500)
In most adoptions, part of the adoption cost involves a charitable donation to the orphanage, which is usually around $2,000. This can be treated as a charitable deduction for tax purposes. Again, if you are in the 25% tax bracket, you may receive a benefit of $500 (25% times $2,000).
Source #5: Employer Contribution ($0 - $5,000)
Many employers today will reimburse a portion of your adoption costs. Most employers reimburse between $1,000 and $3,000; however, some are even more generous. Check with your human resources to see whether your company provides this benefit. This benefit is not taxable for income tax; however, you will pay social security and medicare taxes out of it (7.45%).
Source #6: State Tax Benefits ($0 - ???)
Some states offer tax incentives for adoption as well. These benefits differ by state and may be limited to in-state adoptions, so you will need to check locally for more information. I can confirm that Texas does not offer incentive most likely due to Texas not having a state income tax.

Question #2: How do I get the money when I need it?
Answer: Adjust how much tax is withheld from your paycheck. Most people think they have to pay these taxes up front and then wait for a return. This causes a cash flow problem because you don’t have the cash to pay for the adoption. Waiting to get a return is not always necessary. You can get the money up front to use toward the adoption.

You now know that you get to pay fewer taxes so start having less taken out of your paycheck in the year you expect to complete the adoption. First you need to figure out how much tax you expect to owe in the year you will complete the adoption. Then work with HR or a tax professional to determine how much tax to take out of your paycheck to meet your new lower tax liability. Take the money that you’re saving in taxes each month and apply it toward your adoption expenses.

Your personal situation (adoption timing and income level) can greatly impact the usefulness of this strategy, so as with any tax strategy, you want to know what you’re doing. I’m happy to talk with anyone wanting more information.

Example # 1: (No Employer Contribution)
Sammy and Dora expect to complete an adoption in 2007 and they will have taxable income of $100,000. As such, they had planned to pay taxes of about $18,000 and were having $1,500/mo taken out of their paychecks. Now they know that they will get the tax benefits highlighted above and their tax liability will go down by almost $13,500 to only $4,500. As such, they should have no more than $375/mo taken out of their paychecks. This will save them $1,125/mo that they can use toward the adoption. If they needed to be even more aggressive, they could reduce their tax withholding to zero until completion of the adoption and then pay enough to ensure that they pay in $4,500 by year-end; however, this can be a bit more risky.

Example #2: (Employer Contribution)
The scenario is the same as in example #1 except that Sammy’s employer offers adoption reimbursement of $3,000. They can actually use this reimbursement to reduce the amount of tax withholding they take out also. Sammy and Dora will still owe $4,500; however, they can use the employer reimbursement to pay for $3,000 of that tax liability. Now they can pay $3,000 of their taxes when they receive the employer reimbursement and pay the remaining $1,500 of taxes through payroll deduction. This means that they will need to only take $125/mo toward taxes out of their paychecks – saving an additional $250/mo for a total of $1,375/mo that they can apply toward the adoption costs.

Example #3: (Adoption Completes in 2008)
The scenario is the same as in example #1 except that the adoption isn’t expected to complete until next year. Sammy and Dora should not adjust their taxes for 2007 as they will not receive any of the tax benefits or employer reimbursement in this year. Instead, they should plan to employ their strategy next year when the adoption is expected to complete.

On a side note, if you expect your adoption to complete at the very end of this year and there is possibility of it extending into the next year, you will need a contingency plan. Since, you only receive the benefits in the year that you complete the adoption, you may want to consider paying in taxes monthly or arrange to borrow money, if needed, at year-end to pay taxes if the adoption does not complete in time. You will be able to use your tax benefits in the next year to pay back your debt.

Example #4: (Lower Income Scenario)
This scenario is the same as Example 2; however, Dora decided to leave her job this year and made no income leaving only Sammy’s taxable income of $50,000. Their expected tax liability has now dropped to $6,750. They still expect to receive tax benefits this year in the amount of $13,500 and employer benefits of $3,000; however, that is significantly more than the taxes they expected to pay. Unfortunately for them, the government will not allow you to take more of the tax credit than you owed in taxes this year. Any amount that they don’t get to take this year can be taken in future years though.

As such, this year they will only receive the total employer benefit ($3,000) and tax benefits equal to $6,750 plus the child tax credits ($1,000). They were planning to withhold taxes from their paycheck of appx. $550/mo; however, they now know that they will receive the tax benefits above. In this case, they should reduce their payroll tax deduction to zero saving $550/mo. that they can apply toward adoption expenses. Because they only received $7,750 of tax benefit in this year, they will have lower taxes next year (2008) also by $5,750 (total benefits of $13,500 less amount received in 2007 of $7,750).

Example #5: (High Income Scenario)
If Sammy and Dora make significant income (as deemed by the IRS), they may receive reduced tax benefits from the tax credits and the personal exemption, which “phase out” at higher income levels. However, they would still benefit from the charitable deduction and employer reimbursement. They should meet with a tax professional to best understand the amount of benefit they should expect to receive.

Example #6: (Lower Adoption Costs)
Let's assume the same situation as scenario #2; however, Sammy and Dora's adoption costs total only $8,000. In this case, Sammy and Dora would receive the child tax credit ($1,000), additional personal exemption ($825), charitable deduction ($500), the employer reimbursement ($3,000); however, they would only receive the Adoption Tax Credit in the amount of the total adoption cost ($8,000) less any employer contribution ($3,000). In this case, Sammy and Dora would receive $5,000 of the available $10,960 adoption tax credit. Yes, Sammy and Dora would actually come out ahead by $2,325 (total benefits of $10,325 less the adoption cost $8,000). Of course, we know that this will quickly be consumed by food, diapers, toys, clothes, etc., but it still helps.

Example #7: (Adoption of Domestic Special Needs Child)
If in example #6, the child that Sammy and Dora is adopting domestic and deemed to have special needs, then they are entitled to the entire adoption tax credit of $10,960 even though their adoption costs are lower. This would provide Sammy and Dora an additional $5,960 compared to Example #6.
The definition of special needs is determined by the child's state; however, the definition considers the child's ethnicity, age, whether part of sibling group and medical needs as special needs factors.
CONCLUSION
I know this sounds fairly complex. Please feel free to ask any questions you may have or leave a comment with your e-mail address. We are happy to help in any way we can.

Russ

11 comments:

Anonymous said...

RUSS: My employer contributes $5,000 to adoption expenses. Does that $5,000 reduce the 2007 tax credit of $10,960 or do I get the $10,960 plus $5,000?

Angel said...

So cool that you're employer is so generous toward adoption reimbursement! The great news is that you can get both - the full tax credit and the employer contribution. For more good information, the following website is helpful: http://www.familylife.com/hopefororphans/adoption_tax_credit.asp

Russ

Anonymous said...

Thank you Russ! I have to give a shout out to STATE FARM as they are the wonderful employer that contributes $5,000. I appreciate the link you left. Thanks again!

Krystal said...

Russ,

Great post - I am sure that this wil help many people!!

One thing though, the reimbursed expenses do not qualify for the federal tax credit. So, in example 6, if the employer reimbursed $3k, they would only qualify for a $5k adoption tax credit.

angieshaffer said...

That is great information! Very interesting. Thanks for sharing!

GDS said...

Russ - so glad you suggested that people adjust their withholdings. It's so common for people to think it's good to get a huge refund.

Thanks for the info and advice!
-Greg

Angel said...

Krystal,
You caught me! Thanks for the feedback. I've adjusted example #6 to reflect your correction.

Russ

sweet-P's Mum said...

Russ,

someone directed me to your blog...we are having trouble finding the remaining $3000 needed for our special needs adoption from china. We have tapped out every other resource but i had never considered withholding taxes.

Can you withhold for just a few months (we plan on traveling in March) and then change it back once we are home, or does it have to be the entire year?

We petitioned my husbands employer HARD...three years in a row, they implemented a $5000 benefit for 2008! We feel so lucky, but it is not available until AFTER the adoption is finalized....which helps, but not with immediate expenses.

We are also hoping for a tax return this year...so will file asap.

Your blog addresses this so clearly, thanks for helping other families out with the information!

Hayley
Mum to Piper (Guangdong)
waiting for Paisley! (Jiangxi)

Darlene said...

Russ,
I thank God for you and Angel. My husband and I are praying about adoption right now, and when I saw the costs I started to let fear creep in. I had actually just advised a friend on how God does not give us a spirit of fear, and here I was, getting afraid! Well, I calmed down. Took a deep breath. and I told God I was waiting on Him! He just used you to answer my prayer. Thank you for your service to Him!
Darlene

Matthew Monberg said...

Hey Russ...looking forward to meeting you in person when you're up at the Children's HopeChest office. I've actually taken this post to my accountant to figure out the best way to fund our own Ethiopia adoption. I just heard that the IRS increased the tax credit for international adoption in 2008. Even better news. Thanks again!

Anonymous said...

I heard recently that the adoption tax credit is due to expire in 2010. My question is that if it is not renewed but my adoption is finalized in 2009 or 2010 will we still qualify to use the benefits for the five years or will we only be able to take advantage of it for the 1-2 years.
We are a single income family with three children and our tax liability is not very big so we really need to be able to have the five years to recoup our expenses.