International Adoption
Federal Adoption Tax Credit Information
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Adoptive parents may be able to claim a tax credit on their federal income tax return for qualified adoption expenses. This credit can be claimed even if the adoption has not been finalized or even if the adoption process is interrupted and never finalized. The expenses claimed for an adoption that is stopped are applied to the maximum amount that may be claimed on a second adoption.

The credit is up to $5,000 for each child, or up to $6,000 for a domestic waiting child (called a "special needs" child in IRS publications). The $5,000 credit also applies to international adoptions after finalization. (After 2001, the adoption credit will apply only to domestic waiting children.) The tax credit limit is for expenses associated with each adopted child, rather than an annual limit. The tax credit is progressively phased out for high-income families. The phase-out starts for families with adjusted gross income (AGI) of $75,001 or higher in the year they adopt, and is phased out entirely once their AGI reaches $115,000.

This tax credit is more valuable than a tax deduction because allowable expenses are subtracted dollar for dollar against your tax liability. For example, if you owe $5,000 in federal taxes and have $3,000 in qualified adoption expenses, your tax bill is reduced to $2,000. If your tax bill is smaller than the credit, the unused portion of the credit may be carried forward for up to five years. According to IRS Publication 968, qualified expenses include "reasonable and necessary" adoption fees, attorney fees, and some travel costs, including necessary transportation, meals, and lodging. Expenses related to surrogate parents or adopting a spouse´s child do not qualify for the credit. The credit also does not apply to expenses reimbursed by the government or private programs or for which an income tax deduction or credit already is allowed. Adoptive parents should carefully review the IRS guidelines, preferably with a tax professional, to clarify what expenses qualify for the credit. The credit may be taken for adoption expenses incurred and paid for on or after January 1, 1997.

NOTE: The preceding information reflects laws as of 1997.

Federal Adoption Tax Credit FAQ

The adoption expense tax credit and the exclusion of income from employer adoption programs were modified and made permanent as part of the tax bill signed by the President on June 7, 2001. Below is information that may help you explain the changes to clients and others. The answers are based on past IRS guidance and best conjecture and do not reflect official Treasury Department policy since the IRS has not had a chance to issue new guidelines.

Q. In a nutshell, what are the changes the new tax law made in adoption benefits?
A. Except as noted, after Dec.31, 2001 it:

• Increases the adoption tax credit for all adoptions to $10,000
  
• Makes the credit permanent for all adoptions
  
• Allows the special needs credit to be $10,000, regardless of expenses, beginning in 2003
  
• Increases to $150,000 (previously $115,000) the income amount at which the credit has phased down to zero
  
• Makes the exclusion of income from employer adoption assistance programs permanent, increases the exclusion to $10,000, and increases the income level below which you can claim the full exclusion to $150,000
  
• Applies a cost of living adjustment to the credit and the exclusion beginning in 2003
  
• The adoption credit is allowed against the alternative minimum tax permanently

Q. Which children qualify for the credit?
A. An eligible child is an individual who has not attained age 18 or who is physically or mentally incapable of caring for himself or herself. An eligible child may not be the child of the taxpayer´s spouse.

Q. What presently are qualifying expenses for all adoptions and after Dec. 31, 2002, for non-special needs adoptions?
A. Qualifying adoption expenses are reasonable and necessary adoption fees, court costs, attorney fees, travel expenses (including amounts spent for meals and lodging), and other expenses directly related to, and whose principal purpose is for, the legal adoption of an eligible child. In the case of the adoption of a U.S. citizen or resident, the credit can be taken even if the adoption never becomes final; in the case of an adoption of a child not a citizen or resident of the U.S., the credit can only be taken if the adoption becomes final.

Q. What is a special needs child according to the IRS?
A. An eligible child is a child with special needs if he or she is a citizen or resident of the U.S. and a state determines that the child cannot or should not be returned to his or her parents´ home and probably will not be adopted unless adoption assistance is provided to the adoptive parents.

Q. When can the credit be taken?
A. In the case of a special needs adoption, after Dec. 31, 2002. The credit is allowable in the taxable year in which the adoption becomes final. In non-special needs adoptions and special needs adoption before Dec. 31, 2002, the answer depends on whether the eligible child is a U.S. citizen or resident.

If the child is a U.S. citizen or resident take the credits shown below:

If the child is not a U.S. citizen or resident take the credit as shown below:

Q. What if your regular tax liability for a year is less that your allowable credit for the year?
A. The credit allows you to subtract credit amounts directly from your otherwise owed tax bill, but if you reduce your tax bill to zero and still have credit coming to you, the unused credit amounts can be carried forward to your next 5 tax years, or until it is all used, whichever comes first.

Q. How do I claim the credit?
A. You must file Form 8839 with either Form 1040 or Form 1040A to take the credit. You should maintain records to support any credit claimed.

Q. Can a foreign adoption be a special needs adoption for purposes of the tax credit?
A. No.

Q. Does it make sense to delay final adoption decrees until the time when the increased tax credit has gone into effect?
A. The IRS will very likely issue guidelines on how to handle the periods leading up to the increases in maximum allowable credits and the increases in the special needs credit. Credit for foreign adoptions and special needs adoptions after Dec. 31, 2002 are allowable in the year the adoptions become final. Foreign adoptions became eligible for the increased credit amount in 2002, while special needs adoptions will do so in 2003. Each case would have to be judged individually, but since the potential benefit is substantial, if all other factors are neutral with regard to the timing of finalization, it appears that it would be sensible to wait for the increased tax benefit.

NOTICE: This is not legal advice and should not be relied upon without first consulting your adoption attorney.