Adoption Tax Benefits

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	Tax benefits for adoption Personal Finance Advisor by Deloitte & Touche OnLine September 13, 1999

Qualify for a tax credit or income exclusion up to $5,000.

Recent changes to the federal income tax laws provide benefits to taxpayers adopting a child -- benefits in addition to the personal exemption and child tax credit. Individuals may (1) qualify for a tax credit of up to $5,000 for certain expenses incurred in adopting an eligible child, and (2) exclude from income up to $5,000 paid or reimbursed by an employer under an adoption assistance program. The limit for both the credit and the exclusion is $6,000 if the eligible child is a "special needs child." While taxpayers may claim a credit as well as an exclusion for the expenses of adopting an eligible child, they cannot claim both a credit and an exclusion for the same expense.

Qualifying Expenses: Expenditures that qualify for the credit or exclusion include reasonable and necessary adoption fees, court costs, attorney fees, traveling expenses, and other expenses directly related to the legal adoption of a child.

Qualifying adoption expenses do not include expenses that (1) violate state or federal law, (2) are incurred in a surrogate parenting arrangement or in the adoption of the child of a spouse, (3) are paid with government funds, or (4) are allowed as a credit or deduction under any other federal income tax rule.

Eligible and Special Needs Child: An eligible child must be either under 18 years old or incapable of caring for himself/herself. The child is considered a "special needs child" if he/she is:

A U.S. citizen or resident, and
The subject of a state determination that the child should not be returned to his/her parent’s home and has a condition such that he/she probably would not be adopted unless assistance is provided to the adopting parents.

Limits on Credit and/or Exclusion: The credit and exclusion for qualifying adoption expenses are subject to both a dollar and an income limit.

Dollar Limit: The amount of the adoption credit or exclusion is limited to $5,000 for each eligible child and $6,000 for each special needs child. Beginning in 2002, the adoption credit will only be available if the eligible child is a special needs child and the exclusion for amounts paid by an employer will be eliminated. The above limits are the maximum amount of expenses that can be claimed for all taxable years per effort to adopt a child. For example, if a taxpayer claims an exclusion from income for $4,000 of qualifying adoption expenses paid by an employer for an eligible child in 1998 and then receives an additional $4,000 from the employer’s adoption assistance program for the same child in 1999, only $1,000 of the 1999 expenses would qualify for the exclusion.

Income Limit: Taxpayers will be fully or partially disqualified from claiming the adoption credit or exclusion if their modified adjusted gross income (AGI) is above certain levels. Modified AGI is the taxpayer’s AGI plus foreign earned income exclusion, foreign housing exclusion, and exclusion of income from Guam, American Samoa, Northern Mariana Islands, or Puerto Rico. The following table illustrates the income limitation.

Modified Adjusted Gross Income	Impact on Adoption Credit or Exclusion
$75,000 or less	No impact.
Between $75,000 and $115,000	Credit or exclusion reduced by a percentage; the amount modified AGI exceeds $75,000, divided by 40,000.
$115,000 or more	Credit or exclusion eliminated.

Example: Margaret and John have a modified AGI of $85,000 in 1998 and $95,000 in 1999. They incur qualified expnses in adopting a special needs child of $4,000 in 1998 and $2,000 in 1999. Under the income limit, their credit for both years is reduced. The 1998 credit is reduced by 25 percent [(85,000-75,000) ÷ 40,000] to $3,000, and the 1999 credit is reduced by 50 percent [(95,000-75,000) ÷ 40,000] to $1,000.

When to Claim the Benefit: If the eligible child is a U.S. citizen or resident, the adoption credit or exclusion should be claimed in the later of (1) the year the adoption is finalized, (2) the year the adoption effort ceases, or (3) the year the expenses are paid. If the eligible child is not a U.S. citizen or resident, the adoption credit or exclusion is only available if the adoption becomes final. In this case, the benefit is claimed either in (1) the year the adoption is finalized, or (2) the year the expenses are paid, whichever is later.

Claiming the Credit or Exclusion: Taxpayers must file Form 8839, Qualified Adoption Expenses, with their individual income tax returns in order to claim the credit or exclusion. Married taxpayers need to file a joint return in order to claim the credit or exclusion (unless they meet certain exceptions). To obtain the benefit, the child must have a social security number. For children who are not eligible for a social security number, the IRS will issue either an individual taxpayer identification number or an adoption taxpayer identification number for the child.

These are some thoughts to consider about tax benefits for adoption. Your Deloitte & Touche financial advisor also can provide information and should be consulted before any action is taken.