Lawyers, judges, child advocates, child welfare agency personnel, and prospective adoptive parents should know that as a result of a federal law (P.L. 107-16) enacted in June 2001, but not fully effective until January 1, 2003, that those who adopt special needs children from the foster care system - beginning this year - are entitled to a $10,160 "flat tax credit" without having to show any adoption-related expenses. Proof of those costs had been required before, when the tax credit was actually smaller.

This means that - for families whose adoptions become final in 2003, where the family earns less than $150,000 per year - they can receive the full $10,000 credit on their 2003 tax return when they file in 2004. Those families earning $150,000-189,999 per year will receive a steadily reduced proportion of the credit.

Since this is a nonrefundable tax credit, families with low federal tax burdens cannot get the $10,000 plus refunded to them. However, the law now says they can claim the credit in pieces over a 5-year period, so lower-income adopting families should be able to take full advantage of this significant tax relief. In addition, the law provides for the amount of the tax credit, and the upper-level of family income eligibility, to be adjusted annually by the rise in the cost of living. That's why the 2003 amount has already been set at $10,160 rather than $10,000 as enacted.

Some employers provide financial adoption benefits to employees (e.g., to help employees with their adoption expenses), and the law now provides for up to $10,000 of those benefits to be excludable from a person's federal gross income. Note also that some states also provide for state tax credits or deductions for qualified adoption expenses related to the adoption of special needs children.

How is "special needs" defined for purposes of this tax credit eligibility? Whether a foster child has special needs is determined by each state. However, federal law [42 USC §673(c)] says for federally-supported (Title IV-E) adoption subsidies a foster child cannot be considered to have special needs unless the state 1) concludes that, because of a specified factor or factors, they cannot be placed with adoptive parents without providing a subsidy and 2) determines that a reasonable, but unsuccessful, effort was made to place the child for adoption without a subsidy unless it is in the child's best interests to remain with prospective adoptive parent(s) for whom they have significant emotional ties. Federal law also says a factor or condition related to the "special needs" determination "may include (but is not limited to) ethnic background, age or membership in a minority or sibling group, the presence of a medical condition, or physical, mental or emotional disabilities." This is similar to many state "special needs" definitions.

The governing state definition of special needs, for federal tax credit eligibility, may be included within the state's laws on eligibility for adoption subsidies, or it may be found in child welfare agency rules or regulations. The North American Council on Adoptable Children has a chart with individual state adoption subsidy profiles that has each state's definition of "special needs." This can be found at http://www.nacac.org/subsidy_stateprofiles.html. It is important that adoptive parents keep evidence for their records that their adopted child was one the state determined had "special needs."

The adoption-related changes in federal tax law were the result of Section 202 the Economic Growth and Tax Relief Reconciliation Act of 2001. That law also raised the adoption tax credit beginning in 2002 to $10,000 generally, but except for special needs adoptions finalized after 2002 the credit is still limited to a family's actual "qualifying" adoption expenses (which for special needs adoptions have been estimated by the Treasury Department as an average of $3,400 per family). The current IRS document that explains all the above and other tax benefits of adoption is Publication 968.

Howard Davidson, J.D.
Director, American Bar Association Center on Children and the Law
(ABA Center on Children and the Law)
www.abanet.org/child

© 2003