Common Questions on the Adoption Tax Credit

Thousands of Americans are puzzled about the way the new adoption tax credit works and are calling the National Council For Adoption with Questions.

Taxpayers may wish to ask their tax advisers for guidance, but the fact is that the only sure and solid guidance will come from the Internal Revenue Service (IRS). And IRS has not yet issued any statements formal or informal.

Meanwhile, many who are in the process of adopting or about to begin the process have questions. Here are the seven questions that have been most frequently asked. NCFA, which is neither an accounting firm nor a law firm, is providing its thoughts about what the answers may be, based on NCFA's reading of the law and the report language. Be sure to consult your own CPA or attorney before making any firm decisions.

When does tax credit start?

The law seems very clear that it is for tax year 1997. January 1, 1997, is the critical date to keep in mind. It does seem that a placement made in 1996 could qualify for the tax credit, however, so long as certain requirements are met. Those requirements seem to be: 1) that the adoption is finalized after January 1, 1997; 2) that the expenses which the taxpayer seeks to have reimbursed through a credit were paid after January 1, 1997. There might also be a requirement that the expenses were incurred after January 1, 1997, but this is uncertain.

So how might this work? Mr. And Mrs. Taxpayer could be adopting a child from Korea. The child could have been placed with the family during 1996. The agency which arranged the placement may recommend that adoption be finalized on February 3, 1997. The agency could also ask the family to pay the final installment of the agreed-upon fee, let us say $2,000 at the time of finalization. The fee could be for that portion of the adoption services during the course of the child's life counseling for the parents, reports to Korea, family counseling around adoption issues, obtaining reports about the medical and other records held or subsequently obtained by Korean officials which pertain to the child, etc. In this instance, the final $2,000 installment would seem to fall under the intent of the new law.

For purposes of the tax credit, when is the adoption final?

Several of the sources NCFA has informally consulted with have offered an answer to this question. These sources say that for certain placements, as from Korea when the child has been escorted and no legal process has taken place in the child's country of origin, it is obvious that the adoption becomes final when a U.S. court rules that the adoption is final. These sources also suggest that there is another rule which would seem to make sense: if a U.S. court will make an adoption "final," even in the instance of a court of another country having already issued a ruling that the adoption is final, it is the U.S. court action which decides when the adoption becomes final for purposes of the tax credit. This means, according to these sources, that so long as a U.S. court will process what is often called a "re-adoption," then that action qualifies as the adoption under the tax credit.

What expenses are covered?

It seems that the language is clear: the expense must be "directly related to, and the principal purpose of which is for, the legal adoption of an eligible child by the taxpayer" Any expense for an illegal adoption would be disqualified. Any expense for and ineligible child, such as a step-child, would be disqualified. But other expenses would be very broadly defined. Take for instance, the situation of a child with special needs who can only be properly cared for in the new home if the residence has a wheelchair ramp installed. That question was specifically raised during the course of the debate about the tax credit and the Congressional intent was clear: the expense would be allowed. Therefore, a broad array of expenses would be allowed in addition to those listed in the law: "reasonable and necessary adoption fees, court costs, attorney fees, and other expenses" Among the types of expenses that were mentioned in the report language as being presently covered are "those nonrecurring costs directly associated with the adoption process such as legal costs, social service review, and transportation costs." NCFA sees the coverage, therefore, as quite broad and encompassing all those costs which directly relate to the adoption including all of the examples given above, plus such other expenses as insurance, foster care for the child, etc. NCFA would caution against accepting some of the definitions of acceptable costs as set by some states and some judges, since these are sometimes arbitrary and clearly discriminatory. A federal definition of what is acceptable will be needed from IRS, and a good place to start would be for IRS to list each and every expense that has ever been reimbursed in previous and existing laws under the "nonrecurring costs" language.

Can one benefit from both the tax credit and the employer's adoption assistance program?

NCFA believes that the intent of Congress must have been to allow taxpayers to benefit from both, or the law would not provide both benefits. The question therefore seems to be: what if my income is such that I would qualify for the full $5,000 tax credit and my employer also has a $5,000 adoption assistance plan. Further, what if my total expenses were $15,000 ( not an uncommon sum for adoption these days)? Could I then obtain the $5,000 tax credit and receive $5,000 in non-taxable benefits from my employer's plan? Sources NCFA has talked to believe that the taxpayer in such an instance should be able to obtain $5,000 from each source. In the case of the tax credit, the U.S. treasury is paying the $5,000. In the case of the employer's benefit, it is the employer who is paying the $5,000. The only "loss" to the Treasury and to IRS is the taxes that would otherwise have been payable on the $5,000.

Can one collect for an adoption of a relative, so long as it is not a step-parent adoption?

The answer seems to be yes, although earlier versions of the legislation would not have allowed these adoptions to qualify and the projections of the cost of the tax credit appear to have been based on excluding these types of adoptions. NCFA did not testify in favor of such coverage nor, to the best of NCFA's knowledge, did any of the other witnesses. If this is an area where IRS rules that expenses may be covered, NCFA would not be surprised to see the Congress tighten the language in order to benefit those children whom one usually thinks of as meeting the two requirements of "need" First, the costs of adopting a child who is a relative are very modest, as compared to a non-related child. Second, this category of child was not identified as particularly requiring adoption during the hearings and the mark-up process.

Can one collect the tax credit if no legal adoption took place?

For a domestic adoption, the answer seems to be yes if one reads the report language. The answer seems to be no, if one reads the law itself. In the past, courts have tended to strictly interpret legislative history as meaning the language of the law itself, if there appears to be a conflict between the law and the report language. The law says that the credit is only allowed for an adoption that is "final." This is an area where IRS clarification is certainly needed, especially given the reservations expressed by IRS during the legislative process about areas where there could be opportunities for fraud and abuse.

What is the meaning of "paid" in "an expense which is paid?"

Some of those NCFA has consulted have suggested that if a taxpayer has borrowed funds to cover costs of an adoption- either from a bank, other lending institution, insurance, or a credit card- that no expense has been "paid" since the money is still "owed." The argument has been that if one borrows to cover the costs of a new automobile and if one has the automobile, one may not receive "title" to the automobile until all of the loan is repaid, including any interest. In an adoption, it is unusual for an agency or attorney to allow a child to be placed unless all pertinent fees for services rendered to date have been covered- even if a loan has been necessary for the family to come up with the funds. The reason is simple: children cannot be "repossessed" in the rare instance when a family fails to meet all of its financial obligations to the agency or attorney. If a family has borrowed $5,000 on their credit card to pay some of the transportation costs to go to China or Russia to adopt a child, and that credit card debt is not repaid until after January 1, 1997, that would appear to those of us at NCFA and those we have consulted with informally to be the time when the expenses have been "paid." Again, this seems to be an area where IRS will need to provide specific guidance.