Foster parents perform a critical function in society to help children removed from their biological homes to have as normal and stable of an upbringing as possible. These foster children may be placed temporarily until conditions improve at their original home or they may be placed for the purpose of a future adoption. Although there is often state assistance provided, the foster parents often invest their own significant time and resources into ensuring the success of the children in their charge. To encourage fostering and reduce the financial burden on foster parents, there are significant tax benefits available to them under federal and state law:
QUALIFIED FOSTER CARE PAYMENTS NOT TAXABLE
Foster parents do not include any amounts received during the tax year as qualified foster care payments in their taxable income. 26 U.S.C. §131(a). “Qualified foster care payments” means any payment made pursuant to a foster care program of a state or political subdivision thereof which is PAID BY the state, political subdivision or qualified foster care placement agency and is PAID TO the foster parent for caring for a qualified foster individual in the foster parent’s home or as a difficulty of care payments.
- “Qualified foster individual” means any individual living in a foster family home In which such individual was placed by a state or local government agency or a qualified foster care placement agency. 26 U.S.C. §131(a)(2). This does not apply if the individual is placed informally in another person’s home by agreement of family members without court authorization or state approval.
- “Difficulty of care payments” means “compensation for providing the additional care of a qualified foster individual which is required by reason of a physical, mental or emotional handicap of such individual with respect to which the state has determined there is a need for additional compensation”, the care is “provided in the home of the foster care provider”, and is designated by the state as compensation.” 26 U.S.C. §131(c)(1).
For the purposes of Michigan income taxes, foster care payments (including difficulty of care payments) are not taxed to the extent that they are excluded from adjusted gross income in the Internal Revenue Code. MCL 206.30(l). However, although not taxable, these foster care payments are required to be included in household income for the purposes of calculating a homestead property tax credit, a home heating credit or a farmland property tax credit under Michigan law. Revenue Administrative Bulletin 1988-28.
CLAIMING A FOSTER CHILD AS A DEPENDENT
A foster child may be considered a “qualifying child” for the purposes of being considered a dependent of the taxpayer for federal income tax purposes. “Qualifying child” includes an individual who is “an eligible foster child” of the taxpayer. 26 U.S.C. §152(f)(1)(A)(ii). An “eligible foster child” means “an individual who is placed with the taxpayer by an authorized placement agency or by judgment, decree, or other order of any court of competent jurisdiction.”
A taxpayer can claim the foster child for the purposes of getting the Child Tax Credit (“CTC”). For tax years beginning after December 31, 2017 and before January 1, 2026, the Child Tax Credit is $2,000.00 for each qualifying child. 26 U.S.C. §24(h)(2). The foster child must also meet the other following conditions to be claimed for the Child Tax Credit:
- The foster child is under age 17 at the end of the tax year. 26 U.S.C. §24(c)(1).
- The foster child lived with the taxpayer for more than half of the year. 26 U.S.C. §152(c)(1)(B).
- The child has not provided more than half of his or her own support during the tax year. 26 U.S.C. §152(c)(1)(D).
- The child has not filed a joint return with a spouse. 26 U.S.C. §152(c)(1)(E).
The amount of the credit allowed is reduced by $50.00 for each $1,000.00 (or fraction thereof) that the taxpayer’s modified adjusted gross income exceeds the following threshold amounts:
- $400,000.00 for joint return filers (increased from $110,000.00 by the Tax Cuts and Jobs Act of 2017). 26 U.S.C. §24(h)(3).
- $200,000.00 for filing single, head of household or qualifying widow (increased from $75,000.00 by the Tax Cuts and Jobs Act of 2017). 26 U.S.C. §24(h)(3).
- $55,000.00 for married filing separately. 26 U.S.C. §24(b)(2)(C).
The Additional Child Tax Credit (ACTC) is the refundable portion of the Child Tax Credit up to $1,400.00 per child (meaning that even if your tax liability is zero, the taxpayer may still be entitled to a refund from the federal government up to $1,400.00 per child). This amount is adjusted for inflation for tax years after 2018. This is no longer a separate credit from the CTC (e.g. the refundable credit is the $1,400.00 portion of the $2,000.00 credit, NOT in addition to it). 26 U.S.C. §24(h)(5).
The ability to claim a foster child as a dependent also has other tax benefits:
- Claiming a dependent can make an individual that is considered unmarried eligible to file as head of household. For tax year 2021, head of households can take a standard deduction of $18,800.00.
- A taxpayer can claim up to $4,000.00 as a tax credit for qualified child and dependent care expenses per eligible child or dependent ($8,000.00 for two or more eligible children or dependents). This can make up for some of the costs and expenses for child care expenses not covered by the State of Michigan.
- A taxpayer who itemizes deductions may be eligible to deducted qualified medical expenses incurred by the taxpayer, his or her spouse and all dependents during the tax year that exceed 7.5% of adjusted gross income. Once again, this is only available for expenses that are not reimbursed or covered by the State of Michigan.
If you are eligible to claim a foster child as a dependent on your federal tax return, then you are also eligible to claim the foster child as a dependent on your Michigan tax return. MCL 206.8(2). A taxpayer may claim a dependency exemption against taxable income for every individual who is a dependent of the taxpayer for the tax year. MCL 206.30(2)(a). For tax year 2021, the dependency exemption has increased to $4,900.00, up from $4,750.00 in 2020.
ADOPTION TAX CREDITS
If the foster family ultimately decides to adopt the foster child, then there is a federal adoption tax credit available to help defray the expenses involved. In 2021, a taxpayer is allowed a tax credit for the amount of qualified adoption expenses paid or incurred by the taxpayer up to $14,440.00 per child. 26 U.S.C. §23(a)(1). “Qualified adoption expenses” means reasonable and necessary adoption fees, court costs, attorney fees, and other expenses:
- “Which are directly related to, and the principal purpose of which is for, the legal adoption of an eligible child by the taxpayer.” 26 U.S.C. §23(d)(1)(A).
- “Which are not incurred in violation of State or Federal law or in carrying out any surrogate parenting arrangement.” 26 U.S.C. §23(d)(1)(B).
- “Which are not expenses in connection with the adoption by an individual of a child who is the child of such individual’s spouse.” (No stepparent adoption expenses are deductible). 26 U.S.C. §23(d)(1)(C).
- “Which are not reimbursed under an employer program or otherwise.” (If the state or your employer paid you back for the expenses, they are not deductible). 26 U.S.C. §23(d)(1)(D).
The credit for the expense is allowed, “in the case of any expense paid or incurred before the taxable year in which such adoption becomes final, for the taxable year following the taxable year during which such expense is paid or incurred.” 26 U.S.C. §23(a)(2)(A). “[I]n the case of an expense paid or incurred during or after the taxable year in which such adoption becomes final”, the expense is allowed “for the taxable year in which such expense is paid or incurred.” 26 U.S.C. §23(a)(2)(B). Generally, the adoption credit is NOT REFUNDABLE, meaning that it is only allowed up to the amount of taxable income that the taxpayer has for the tax year.
However, in the case of adopting a “child with special needs” which become final during the 2021 tax year, the taxpayer gets a full refundable credit of $14,440.00 per child regardless of the actual expenses incurred and regardless if the credit exceeds taxable income for the tax year. 26 U.S.C. §23(a)(3). A “child with special needs” means any child with ALL of the following:
- “A State has determined that the child cannot or should not be returned to the home of his parents.” 26 U.S.C. §23(d)(3)(A).
- “Such State has determined that there exists with respect to the child a specific factor or condition (such as his ethnic background, age, or membership in a minority or sibling group, or the presence of factors such as medical conditions or physical, mental, or emotional handicaps) because of which it is reasonable to conclude that such child cannot be placed with adoptive parents without providing adoption assistance.” 26 U.S.C. §23(d)(3)(B).
- “Such child is a citizen or resident of the United States.” 26 U.S.C. §23(d)(3)(C).
In any event, the availability of the adoption tax credit is subject to income limitations. For tax year 2021, the limits are as follows:
- Families with a modified adjusted gross income below $216,660 can claim the full credit.
- Families with a modified adjusted gross income from $216,660 to $256,660 can claim the partial credit that gradually phases out as income approaches $256,660
- Families with a modified adjusted gross income above $256,660 cannot claim the credit at all.
Michigan previously had an Adoption Income Tax Credit that provided $1,200.00 per child as a credit against state tax income, but this was repealed and eliminated by the Michigan Legislature and the governor in 2011.
MICHIGAN ADOPTION SUBSIDIES NOT TAXABLE
Michigan has three adoption assistance programs to assist families who adopt eligible foster children up to age 18. The programs are funded by both federal and state funds and provide financial assistance including:
- Adoption Assistance – a monthly payment to assist with the expenses of raising an eligible child. Medicaid is also available for many children who receive adoption assistance.
- Non-recurring Adoption Expenses – reimbursement to adoptive parents up to $2,000 for specific expenses of adopting an eligible child.
- Adoption Medical Subsidy – reimbursement of approved expenses related to physical, mental, or emotional conditions that existed, or the cause of which existed, prior to adoption.”
The Internal Revenue Service determined in Revenue Ruling 74-153 that state payments to adoptive parents for the support and maintenance of their adoptive child are general welfare payments not includible in the taxpayer’s gross income. In addition, Michigan does not require the taxpayer to include these payments in taxable income for the purpose of determining state income tax liability.
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If you have further questions about tax deductions and credits related to foster children or you need legal representation, then do not hesitate to contact the experienced attorneys at Kershaw, Vititoe & Jedinak PLC for assistance today.