New Adoption Tax Credit Signed into Law

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On June 7, 2001, President Bush signed into law the Economic Growth and Tax Relief Reconciliation Act of 2001 (P.L. 107-16). In addition to making possible this summer's income tax rebates, the new law expands the adoption tax credit. The revised credit, effective for adoptions finalized starting in tax year 2002, includes a higher credit amount, and will be available to a greater number of adoptive families. The improvements do not, however, make the credit immediately more accessible to families who adopt children with special needs.

Available since tax year 1997, the existing adoption tax credit allows families with modified adjusted gross incomes less than $115,000 to subtract from their tax burden qualified adoption-related expenses-as much as $5,000 for each international or private domestic adoption, or $6,000 for each special needs adoption. Adoptive parents whose employers provide adoption benefits may also be able to exclude those benefits from their income.

Features of the revised credit, as shown in the chart below, include a higher family income eligibility cutoff ($190,000), an increased credit limit of $10,000 for all adoptions, and, starting in 2003, annual cost-of-living adjustments for both the credit and income limit (but not for the employer benefit exclusion). Both the current and revised credit can be claimed over five years. In other words, families who do not owe enough tax to take the full credit for the year in which the adoption is finalized can apply the remaining credit to the next four years' taxes.

Key Features of the Existing and Revised Tax Credits

Existing Tax Credit Revised Tax Credit Maximum Credit Amount $5,000 ($6,000 for special needs adoption) $10,000 for all adoptions Income Limit $75,000 for full credit (phased out at $115,000) $150,000 for full credit (phased out at $190,000)
Expense Documentation Required for all adoptions Required for all adoptions in 2002, but only non-special needs adoptions thereafter Cost-of-Living Adjustment No Yes, for credit and income limits starting in 2003

Issues of Equity

By tax year 2003, the revised credit will also be more accessible for families who adopt children with special needs. Starting that year, the credit will function as a flat tax credit. That means every adoptive parent or couple who finalizes the adoption of a child with special needs and earns less than $150,000 can claim the full credit without documenting that they incurred a specific level of qualified expenses.

Documentation requirements under the existing credit have been a significant barrier for families who adopt children with special needs. In its October 2000 Report to Congress on Tax Benefits for Adoption, the U.S. Department of the Treasury states that, in tax year 1998, adoptive parents of only 15 percent of eligible special needs adoptees applied for the credit. In monetary terms, special needs adoptions accounted for just eight percent of the total credit taken. On average, such families generated about $3,400 in qualified adoption expenses per adoption. Parents who adopted internationally claimed roughly $9,800 per adoption.

As the Treasury report indicates, families who adopt internationally or privately can easily document qualified adoption-related expenses. Before placement, they typically incur significant agency fees, home study costs, travel expenses, attorneys' fees, and the like. For families who adopt from public agencies, costs for home studies and agency fees are often waived or reimbursed through the nonrecurring costs provision of the adoption assistance program. These families' adoption-related costs are more likely to include ongoing medical services and counseling, larger vehicles, and housing modifications-for accessibility or to fit a larger family-that occur before and after a child or sibling group is placed. Such costs do not count as "qualified adoption-related expenses" for the credit.

As long as families who adopt children with special needs must document qualified expenses, they will not be able to take full advantage of the existing or revised credit. This makes the year delay in waiving the documentation requirements under the new law very troubling. While private and international adopters are enjoying the benefits of the higher income limit and credit in 2002, special needs adopters will still be limited to the few expenses that qualify for the credit.

Possible Consequences

By increasing the credit and income limits for 2002, but delaying the flat tax credit provisions for adoptions involving children with special needs until 2003, the new law creates a significant financial disincentive for families to finalize adoptions from foster care in 2002. NACAC has already heard of parents who plan to adopt from foster care, but intend to delay finalization until after January 1, 2003, so they can take full advantage of the higher credit.

The most recent Adoption and Foster Care Analysis and Reporting System (AFCARS) data suggests that the number of children in foster care who need adoptive families is increasing. On March 31, 1998, an estimated 110,000 children were waiting. On the same date in 2000, about 134,000 foster children were waiting to be adopted. As more children wait for adoptive homes, it is increasingly important that systems designed to increase permanency options for them truly work toward that goal and not against it.

Unfortunately, the current and revised tax credits do little to encourage additional adoptions from foster care in 2001 and 2002-the final two years of the federal adoption incentive bonus program. As the law is currently written, states will not have an improved tax credit tool for promoting adoptions from foster care until the incentive program is over.

Time for a Solution

A strong bipartisan effort, led by Senators Larry Craig (R-ID), Mary Landrieu (D-LA), and Charles Grassley (R-IA), made the revised tax credit possible. Thanks to their efforts, the new law will reduce more barriers to adoption than the existing adoption tax credit. And there is still time to make sure that the law fairly serves the interests of those who adopt children with special needs.

As the flat tax credit provision for 2003 acknowledges, the costs of special needs adoption are very real, but hard to neatly categorize. If the law were amended to allow those who adopt children with special needs to participate immediately in the credit's intended benefits, the legislation would meet its goal of equitably promoting adoptions of all types. And, if a flat special needs adoption tax credit became effective January 1, 2002, more families would be able to make children's dreams of permanence come true that much sooner.

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