Are Surrogacy Expenses Tax Deductible?

Are Surrogacy Expenses Tax Deductible in 2024?

Most surrogacy expenses are not federally tax-deductible. The IRS has no statute that explicitly covers surrogacy costs, and the case law that does exist cuts against intended parents in most scenarios. That said, a narrow slice of qualifying medical expenses may survive scrutiny under IRC Section 213, and business owners with the right entity structure can potentially do better than Schedule A itemization alone.

Here is what the tax picture actually looks like for someone at the $5M+ level.

Why the 7.5% AGI Floor Kills Most Surrogacy Deductions for High Earners

IRC Section 213 allows a deduction for unreimbursed medical expenses exceeding 7.5% of adjusted gross income. For a W-2 earner with $1M in AGI, that floor sits at $75,000. If your deductible IVF costs total $50,000, you get zero federal benefit from Schedule A. The deduction threshold simply swallows the expense.

This is the counterintuitive reality that surrogacy agencies rarely advertise. The medical expense deduction is structurally designed for middle-income households. At FATFIRE income levels, it functions more as a planning distraction than a genuine offset.

According to SART national data, total surrogacy costs in the US commonly run $100,000 to $200,000 when you combine agency fees, legal costs, IVF procedures, and surrogate compensation. Even if a meaningful portion of that were deductible in principle, the AGI floor would eliminate the benefit for most readers here.

The practical implication: stop optimizing Schedule A and start thinking about entity structure, HSAs, and how surrogacy fits into your broader family-building tax strategy. Those are the levers that actually move.

Which Surrogacy Costs Qualify as Medical Expense Deductions Under IRS Rules?

IRS Publication 502 defines deductible medical expenses as costs paid for the diagnosis, cure, mitigation, treatment, or prevention of disease. The expenses must be primarily for medical care rather than personal purposes. That distinction is where most surrogacy costs fail.

The Tax Court addressed this directly in Magdalin v. Commissioner (T.C. Memo 2008-293). A single male taxpayer attempted to deduct egg donor and surrogate-related expenses. The court denied the deductions, ruling that costs not directly treating the taxpayer's own medical condition do not qualify under IRC Section 213. The surrogate's medical care is not the intended parent's medical care.

The Eleventh Circuit offered a more expansive reading in Morrissey v. United States (871 F.3d 1260, 2017), holding that IVF-related expenses incurred by a same-sex male couple could qualify as deductible medical expenses. Practitioners cite Morrissey when structuring deduction strategies, but it has not been universally adopted, and the IRS has not issued conforming guidance.

The honest answer is that the deductibility of IVF costs paid on behalf of a surrogate remains unsettled. What is settled: surrogate compensation, agency fees, and legal fees are not deductible under any currently recognized IRC provision.

How the IRS Classifies Surrogate Compensation for Tax Purposes

Surrogate compensation, typically $35,000 to $60,000 in the current US market, is taxable income to the surrogate. The intended parents cannot deduct it as a medical expense, a charitable contribution, or a business expense under any currently recognized IRC provision, regardless of how the surrogacy contract characterizes the payment.

The legal rationale traces to IRS Revenue Ruling 73-201, which established that medical expenses paid on behalf of a third party are not deductible by the taxpayer unless that third party qualifies as a dependent. A surrogate is not a dependent. Her compensation is not "medical care" under Section 213(d). The surrogate's own medical costs paid by intended parents fall into the same trap.

This is the single largest cost category in a surrogacy arrangement, and its complete non-deductibility is frequently misunderstood. The ABA's Family Law Quarterly has noted that legal fees for establishing parental rights are classified as personal legal expenses rather than medical expenses, making them non-deductible under IRC Section 213 as well.

Understanding how non-deductible expenses affect your tax basis matters here because these costs do not simply disappear from your financial picture. They affect how you think about the total after-tax cost of the arrangement and where you allocate capital.

Can an LLC or S-Corp Be Used to Deduct Surrogacy-Related Medical Expenses?

For business owners, entity structure is where the real planning opportunity lives. Self-employed individuals and business owners with S-corps or single-member LLCs may be able to establish a Health Reimbursement Arrangement (HRA) or a Section 105 medical reimbursement plan. These plans reimburse qualifying medical expenses, including IVF costs that meet IRC Section 213(d) standards, as a business deduction.

The critical advantage: this approach bypasses the 7.5% AGI floor entirely. You are not itemizing on Schedule A. You are running qualifying medical costs through an employer-sponsored plan at the entity level, converting them into above-the-line business deductions.

The potential tax savings range from $15,000 to $40,000 depending on your marginal rate and the specific costs involved. At a 37% federal rate plus applicable state taxes, even $40,000 in deductible IVF expenses run through an HRA produces roughly $15,000 to $18,000 in federal tax savings that Schedule A would never deliver.

This is not a retail tax strategy. It requires proper plan documentation, compliance with ACA rules for HRAs, and coordination with your tax counsel. The IRS scrutinizes HRAs established primarily to capture personal medical costs, so the business purpose and structure must be defensible. Review aggressive tax planning strategies and considerations before assuming any structure is automatically safe.

Irrevocable trusts are a separate question. Trusts generally cannot deduct medical expenses for beneficiaries in the same way individuals can, and the rules around allowable expenses paid from trusts are narrow. A trust is not the right vehicle for surrogacy expense optimization.

How Do Surrogacy Tax Deductions Compare to the Adoption Tax Credit Under IRC Section 23?

The adoption tax credit under IRC Section 23 is a dollar-for-dollar credit worth up to $15,950 per child for tax year 2023, indexed for inflation. A credit is categorically more valuable than a deduction: it reduces your tax liability directly rather than reducing taxable income.

There is a catch that makes this irrelevant for most FATFIRE households. The credit phases out completely for taxpayers with modified AGI above approximately $263,410 in 2023. If your household income is $500,000 or more, you receive zero benefit from IRC Section 23.

This phase-out threshold is not a planning nuance. It is a hard wall. The adoption tax credit is designed for middle-income families, and the income limits have not kept pace with inflation in any meaningful way. Most readers here are fully phased out.

The practical implication: surrogacy, despite its tax complexity and limited deductibility, may still be the more financially rational family-building path for ultra-high earners. You cannot access the adoption credit anyway. The comparison that matters is between the after-tax cost of surrogacy versus the after-tax cost of adoption, not the theoretical tax benefits of each.

Understanding understanding tax-deductible versus tax-deferred benefits provides useful framing here. The adoption credit is neither deductible nor deferred for high earners. It simply does not exist at your income level.

What Are the Tax Implications of International Surrogacy Arrangements for US Citizens?

International surrogacy, common in Canada, Colombia, and Georgia (the country), creates a layer of US tax complexity that domestic arrangements do not. Intended parents frequently hold funds in foreign accounts to pay overseas agencies. That triggers FATCA reporting obligations under Form 8938 if foreign financial assets exceed applicable thresholds, and FBAR filing requirements under FinCEN 114 if foreign account balances exceed $10,000 at any point during the year.

Penalties for non-compliance start at $10,000 per violation. Willful violations carry penalties up to the greater of $100,000 or 50% of the account balance. This is not a gray area. The filing requirements apply regardless of whether the funds are ultimately used for a personal purpose like surrogacy.

If you pay a foreign surrogate directly, rather than through a US agency, you may face withholding analysis under IRC Section 1441. Payments to non-US persons for services can trigger withholding obligations, and the characterization of surrogate compensation as a "service" versus a "medical arrangement" has not been definitively resolved in the cross-border context.

Cross-border tax planning for international situations requires coordination between your US tax counsel and local advisors in the surrogacy country. Do not assume that because the arrangement is legal in the foreign jurisdiction, the US tax treatment is straightforward. It is not.

Does California Offer State Tax Credits for Surrogacy or Fertility Treatment Expenses?

State-level tax treatment of surrogacy expenses varies significantly, and the specifics matter. California conforms to the federal IRC Section 213 framework for medical expense deductions, which means the same 7.5% AGI floor applies at the state level. California's top marginal income tax rate is 13.3%, so a qualifying medical deduction that survives the AGI floor is worth meaningfully more on a combined federal-state basis than the federal rate alone suggests.

California does not offer a standalone surrogacy tax credit. However, the state's conformity to federal medical expense rules means that IVF costs deductible at the federal level are also deductible for California income tax purposes, subject to the same floor.

Several other states have enacted fertility-specific legislation or tax provisions worth knowing:

• New York: Conforms to federal medical expense deduction rules. No standalone fertility credit, but the state's 10.9% top rate amplifies the value of any qualifying deduction.
• Illinois: Has enacted the Fertility Treatments Coverage Act requiring insurance coverage for fertility treatments, which can reduce out-of-pocket costs that would otherwise need to be deducted.
• Maryland: Offers a fertility treatment tax credit of up to $3,000 for qualifying expenses, with income thresholds that phase out the benefit at higher income levels.
• Arkansas: Provides a state income tax deduction for fertility treatment expenses, though the structure mirrors the federal approach.

The honest assessment for FATFIRE-level earners: state credits and deductions at these income levels are marginal. The AGI floors and phase-outs that limit federal benefits apply at the state level too. The entity-structure approach discussed above delivers more consistent value across jurisdictions than chasing state-specific credits.

Maximizing What You Can Actually Recover: A Practical Framework

Given the constraints above, here is how to think about surrogacy expense optimization if you are at the $5M+ level:

Step one: Separate the deductible from the non-deductible before you spend. IVF procedures, embryo transfer costs, and prescription medications for fertility treatment are the categories most likely to survive IRC Section 213 scrutiny, particularly if the medical need is documented. Get itemized invoices from every provider. Aggregate these costs separately from surrogate compensation, agency fees, and legal fees.

Step two: Run qualifying medical costs through an entity if you have one. If you own an operating business structured as an S-corp or C-corp, work with your tax counsel to establish a properly documented HRA before the surrogacy cycle begins. Retroactive plan establishment does not work. The plan must be in place before the expenses are incurred.

Step three: Cluster expenses where possible. If you are going through multiple IVF cycles across calendar years, consider whether concentrating qualifying medical expenses into a single tax year creates any Schedule A benefit. At $1M AGI, you need $75,000 in qualifying medical expenses before the first dollar is deductible. At $500,000 AGI, the floor drops to $37,500. Clustering matters more at lower income levels, but it is worth modeling.

Step four: Document everything as if you are going to be audited. The Magdalin precedent means the IRS will scrutinize surrogacy-related medical deductions. Keep physician letters documenting medical necessity, itemized invoices separating medical from non-medical costs, and copies of the surrogacy agreement. Understand how non-deductible expenses affect your tax basis so you are not surprised by the after-tax math.

Step five: Do not conflate tax planning with financial planning. The tax savings available on a $150,000 surrogacy arrangement, even in the best-case entity-structure scenario, are unlikely to exceed $40,000 to $50,000. That is meaningful, but it is not the primary financial variable. Cash flow timing, opportunity cost of capital, and long-term estate planning around tax implications of gifting to family members are often more consequential decisions.

HSA Eligibility and Pre-Tax Accounts for Surrogacy Costs

IRS Publication 969 governs HSA-eligible medical expenses. The qualifying standard mirrors IRC Section 213(d), which means only the subset of surrogacy costs that constitute direct medical care, primarily IVF procedures and related fertility treatments for the account holder or their spouse, may be paid from an HSA on a pre-tax basis.

Surrogate compensation, agency fees, and legal fees are not HSA-eligible. The surrogate's medical costs paid by intended parents are also not HSA-eligible, for the same reason they fail under Section 213: the surrogate is not the account holder or a qualifying dependent.

The HSA contribution limits for 2024 are $4,150 for individual coverage and $8,300 for family coverage. These amounts are useful for capturing the deductible portion of your own fertility-related medical costs, but they are not a meaningful offset against a $150,000 surrogacy arrangement. Think of HSA contributions as a supplementary tool, not a primary strategy.

Flexible Spending Accounts (FSAs) follow the same qualifying expense rules and carry use-it-or-lose-it restrictions that make them less useful for multi-year surrogacy processes. If your employer offers a dependent care FSA, note that it covers childcare costs after the child is born, not surrogacy expenses incurred before birth.

Audit Risk and Documentation Standards

The combination of large dollar amounts, unsettled case law, and the IRS's lack of explicit surrogacy guidance creates real audit exposure. If you claim IVF costs related to a surrogate as medical expense deductions, you should be prepared to defend the position.

The Morrissey decision gives practitioners a reasonable basis for the deduction in certain fact patterns, particularly where the taxpayer has a documented medical condition related to infertility. The Magdalin decision cuts the other way where the expenses are primarily for a surrogate's medical care rather than the taxpayer's own treatment.

Document the medical necessity of the IVF procedure from your own physician's perspective. Obtain itemized invoices that clearly separate your qualifying medical costs from the surrogate's costs. If you are taking an aggressive position, attach a disclosure statement to your return under IRC Section 6662 to reduce the risk of accuracy-related penalties.

Work with a tax attorney, not just a CPA, if you are claiming contested deductions in this area. The distinction matters: attorney-client privilege protects communications with your tax attorney, while CPA work product does not carry the same protection in IRS proceedings. For calculating your potential tax liability across multiple scenarios before filing, model the conservative and aggressive positions separately so you understand the risk-adjusted outcome.

References

• Internal Revenue Service -- "Publication 502: Medical and Dental Expenses" (2024)
• Internal Revenue Service -- "Internal Revenue Code Section 213: Medical, Dental, etc., Expenses"
• Internal Revenue Service -- "Internal Revenue Code Section 23: Adoption Expenses"
• United States Tax Court -- "Magdalin v. Commissioner, T.C. Memo 2008-293" (2008)
• United States Court of Appeals, Eleventh Circuit -- "Morrissey v. United States, 871 F.3d 1260" (2017)
• Internal Revenue Service -- "Revenue Ruling 73-201" (1973)
• Society for Assisted Reproductive Technology (SART) -- "SART National Summary Report" (2022)
• Internal Revenue Service -- "Publication 969: Health Savings Accounts and Other Tax-Favored Health Plans" (2024)
• American Bar Association -- "Family Law Quarterly: Surrogacy Law and Taxation"