You won’t run across it very often, because the number of surrogacies compared with conventional births is very small. Generally, surrogacy arrangements are made through surrogacy agencies. Surrogacy is a legal arrangement – the surrogate mother, the parents and the agency all have entered into a binding contract and in the event of a breach of that contract, can be held to the terms of the agreement.

The Internet contains a wide variety of opinions related to the taxability of the surrogacy fee to the surrogate mother. Some authors classify this fee as a gift; however, a U.S. Supreme Court decision (Commissioner vs. LoBue, Philip (1956, S Ct)) stated that, for tax purposes, gifts must be made out of detached or disinterested generosity. Any payment that parents make to a surrogate mother cannot reasonably be considered detached or disinterested, so surrogate fees are not gifts.

On the other hand, many surrogacy agencies advise their clients that surrogacy payments are for pain and suffering and thus are exempt under IRC Sec 104. This section is about “compensation for injury or sickness”; however, the term “pain and suffering” does not appear anywhere in that section. Surrogacy does not meet the definition of an excludable physical injury under IRC Sec 104 such as an injury associated with a car accident, bungled surgery or other accident. Thus, surrogacy fees do not fall under the compensation exclusion for injury or sickness.

Sec 61 states, “Except as otherwise provided, gross income means all income from whatever source derived.” There is no exception in the code for surrogacy fees, so such fees are considered taxable income for the surrogate mother. To complicate matters, the surrogate mother is providing a personal service and thus may be subject to self-employment tax in addition to income tax if such a fee is received in the course of a business.

To be subject to Social Security (SE) tax, the surrogacy arrangement would have to rise to the level of a trade or business. The determination of whether that is the case is dependent on the facts and circumstances of the individual surrogacy. For instance, if a surrogate has entered into such an arrangement previously or intends to do so again, the fee will likely be considered self-employment income. However, if the surrogacy is a one-time activity, an argument could be made that this act is not a business—in which case the surrogacy fee would not be subject to SE tax.

If the fee is considered self-employment income, it may be offset with benefits that are available to any self-employed taxpayer, including the ability to deduct health insurance above the line rather than as an itemized deduction and the ability to make deductible contributions to a self-employed retirement plan or IRA. Although there are not many deductible business expenses in such a situation, the legal or other costs associated with drafting and executing the surrogacy contract are deductible.

A self-employment surrogacy activity would fall into the category of a specified service business for the purposes of the Sec 199A self-employed and passthrough business deduction. Thus, provided that the surrogate mother’s return (for 2022) has taxable income that does not exceed $170,050 (or $340,100 if she is married and files a joint return with her spouse), she would be eligible for the IRC Sec 199A pass-through deduction, which is equal to 20% of the net self-employment income. However, this deduction phases out at 2022 taxable incomes between$170,050 and $220,050 (or $340,100 and $440,100 if filing jointly). The income from self-employment surrogacy can be used to determine the earned income tax credit if a surrogate mother is otherwise qualified.

Unfortunately, tax novices on the Internet are creating their own interpretations of the tax code, and many of them are attempting to justify their preferences instead of describing the actual rules.

As a result, many—dare we say, most—surrogate mothers are not reporting their surrogacy income. The IRS is not catching up with them because neither the parents nor the agencies are issuing 1099-NEC forms to surrogate mothers. The parents are under no obligation to issue a 1099-NECbecause, for them, the payment is not related to a business. The agency, on the other hand, is a business, so if the surrogacy fee passes through it, the agency is obligated to issue a 1099-NEC.

Surrogate mothers’ expenses are not specifically addressed in the IRC or in other regulations. Under current tax law, the only place that a surrogate fee could be deducted is as a medical expense. However, consider the following:

A surrogate mother is, by definition, neither the taxpayer nor the taxpayer’s spouse, and she is typically not a dependent either. An unborn child is also not a dependent (Cassman v. United States, 31 Fed. Cl. 121 (1994)). Thus, medical expenses paid to a surrogate mother and her unborn child do not qualify for a medical deduction.

This fee also cannot be construed as a treatment for a female taxpayer’s inability to conceive.

Thus, the new parents cannot deduct the surrogacy fee or any agency fees, legal fees, and medical expenses for the surrogate mother and unborn fetus.