Beginning in 1997, you may be able to take a new tax credit of up to $5,000 for adoption expenses ($6,000 for a "special needs" child). Also, beginning in 1997, qualified adoption expenses paid by your employer, may also be excluded from your income (again, $5,000 for an adoption, $6,000 for "special needs"). You may also be eligible for both the tax credit, and the employer paid exclusion.

First, let's start with some basic terminology:

Tax CREDIT - A dollar for dollar tax reduction in your overall tax liability.

Example: John and Mary Smith adopt a child in 1997. The Smiths have a joint income of $45,000, and their total tax liability as reported on their W-2 is $9,000. The Smiths paid qualified adoption expenses of $13,500.

The Smiths will receive a tax credit of $5,000. Their overall tax liability is $9,000 - $5,000 = $4,000.

Tax DEDUCTION- A tax deduction lowers your income, which in turn lowers your taxes according to your tax bracket.

Qualifying Expenses - Reasonable and necessary adoption fees. These expenses include: Adoption agency fees, attorney fees, court cost, traveling expenses (including amount spent for meals and lodging) while away from home, and other direct expenses whose principle purpose is for the legal adoption of a child.

Non-qualifying Expenses - Expenses that do not meet the guidelines for the adoption tax benefits. Non-qualified expenses include: expenses which violate state or federal law, expenses for carrying out a surrogate parenting arrangement, cost of adoption of a spouses child, expenses paid using federal state or local funds, expenses used as a credit or a deduction elsewhere on a tax return, expenses paid or reimbursed by your employer,

Example: John and Mary Smith adopt a child in 1997, not considered special needs. The Smiths have a total tax liability, as reported on their W-2, of $9,000. The Smiths paid qualified adoption expenses of $13,500. Their employer paid 7,000 toward their adoption cost. The $13,500 expenses are:

Adoption agency fee $ 5,000

Legal fees 3,000

Travel 2,500

Homestudy 1.500

Misc. costs 1,500

$ 13,500

Paid by John's employer (7,000)

State assistance program (2,500)

Total paid $ 4,500

The Smith's are entitled to a $4,500 tax credit. Their tax liability is $9,000 - $4,500 = $4,500. In addition, $5,000 of the $7,000 paid by John's employer is not included in his W2 income.

Eligible Child - A child under 18 years old, or, physically or mentally incapable of caring for himself or herself.

Special Needs Child - There are three tests to meet for your child to be considered a special needs child:

He or she must be a citizen of the United States,
The state determines your child cannot or should not be placed in the biological parents home,
The state has determined there exists a specific factor or condition (such as ethnic background, age, membership in a minority group, sibling group, or mental physical or emotional disabilities). Due to these factors, the child probably will not be adopted unless adoption assistance is provided.
** Note ** An international adoption cannot qualify as special needs, even if the above conditions are met. The maximum benefit for an internationally adopted child is $5,000.

Example: John and Mary Smith adopt a child in 1997. The Smiths have a total tax liability, as reported on their W-2, of $9,000. The Smiths paid qualified adoption expenses of $13,500. The adopted child was born in Indiana. After revoking the biological parents rights, the state has determined the child to be special needs.

The Smiths will receive a tax credit of $6,000. Their overall tax liability is $9,000 - $6,000 = $3,000.

Example: Example: John and Mary Smith adopt a child in 1997. The Smiths have a total tax liability, as reported on their W-2, of $9,000. The Smiths paid qualified adoption expenses of $13,500. The Smith's traveled to Russia to adopt the child. The Russian government revoked the biological parents rights, and the state has determined the child to be special needs.

Since the child was internationally adopted, the Smiths tax credit is limited to $5,000. Their overall tax liability is $9,000 - $5,000 = $4,000.

Second, there are limitations....

The credit is limited to $5,000, ($6,000 special needs), for each EFFORT to adopt an eligible child.
The limit of $5,000 ($6,000 special needs) is per effort, regardless of number of years.
The credit starts being phased out at a joint income of $75,000, and is totally eliminated if your joint income is over $115,000.
The credit cannot be greater than your liability (less certain exclusions). Any unused credit can be carried forward up to 5 years.
For an international adoption, the credit cannot be taken until the adoption becomes final.
There is no credit for expenses incurred before 1997.
Adopting couples must file a joint return (except for cases of legal separation or divorce).
Finally, file the form!

Use form 8839, either with form 1040 or 1040A.

Len Titone is an independent CPA, and is currently the Treasurer of Coleman Adoption Services Inc., oh, and an adoptive parent...

© Fostering Families' Magazine

Credits: Len Titone