To Adoptive Parents, the Government Gives Its Own Kind of Blessing

Claudia and George Gunderson consider themselves twice blessed.

First, after several years of trying, the Illinois couple were able to adopt a healthy baby boy. Andrew was placed with them last October--just in time for the holidays.

Second, thanks to new tax breaks that went into effect at the beginning of 1997, they will be able to recoup nearly half of the $11,000 they spent on the adoption process.

Indeed, since January 1997, adoptive parents have eligible for the most generous tax break available to individuals--credits and “income exclusions” that can amount to as much as $12,000 per adopted child.

“This is just such a great thing,” Claudia said. “We wanted a child so badly that we were going to adopt no matter what. But we really lucked out that the tax breaks went into effect when we got him.”

Still, the Gundersons, like millions of adoptive parents, have found that getting the tax breaks can take almost as long as getting the baby. Although they incurred the bulk of their expenses in early 1997 and received their son later that year, they won’t be able to claim the adoption tax credits until they file their 1998 return in early 1999.

Moreover, the rules on adoption tax credits, though fairly straightforward at first glance, carry a host of limitations that restrict who can claim the credits and for how much. In fact, many adoptive parents may find they don’t qualify at all.

Here’s a guide to the new adoption tax breaks, including which expenses qualify for credits and when and how they can be claimed:

The Basics: A provision in the 1996 Minimum Wage Law created a tax break that allows adoptive parents who meet income and other criteria to receive tax credits of up to $5,000 to recover out-of-pocket expenses related to the adoption. (Tax credits reduce your federal income tax on a dollar-for-dollar basis. As a result, credits for people in the 28% tax bracket are more than three times as valuable as tax deductions, which reduce the amount of total income subject to tax.)

If you adopt a so-called special-needs child--a child who has disabilities, is older or is otherwise considered hard to place--the credits can amount to as much as $6,000 per adopted child.

In addition, up to $5,000 of adoption assistance from your employer, ranging from counseling to employer-paid travel, can be excluded from your income. (If you adopt a special-needs child, up to $6,000 in employer-paid adoption assistance is excluded from income.)

Taxpayers can claim both the income exclusions and the credits for the same adoption. But they cannot claim tax breaks in excess of their allowable expenses. In other words, if you spend $4,000 in unreimbursed qualifying adoption expenses, that’s the most you can claim in tax breaks.

Allowable Expenses: Qualifying adoption expenses can include everything from attorney fees and court costs to travel expenses and fees paid to county and country offices that facilitate the adoption. The credit even allows adoptive parents to recoup the cost of home improvements required to accommodate the new family member, such as putting in a ramp or an elevator for a child in a wheelchair or adding on to a house if county welfare authorities say you can’t adopt without more room.

In addition, the credit can be used to offset medical expenses the adoptive parents paid on behalf of the birth mother, in states where these payments are not banned by law. (Any expenses that violate a state or federal law do not qualify for credits.)

Note that you cannot claim tax credits for expenses that were reimbursed by an employer, insurer or any other party.

Income Phaseouts: The credits are phased out for parents earning more than $75,000. Those who earn between $75,000 and $115,000 can claim partial credits, although those earning more than $115,000 cannot claim credits at all.

These income restrictions do not vary based on marital status.

When Credits Are Claimed: The tax credits can be claimed for the year in which the adoption becomes final or the year following the year in which the expenses are incurred. (Expenses incurred prior to 1997 do not qualify for credits.) As in the Gundersons’ case, children are often placed in adoptive homes before all of the paperwork is complete.

Consequently, although the Gundersons can claim Andrew as a dependent for the 1997 tax year, they will not be able to claim the adoption tax credits until they file their 1998 tax return a year from now. The court order that will make Andrew irrevocably theirs isn’t expected to be signed until April.

If you attempted to adopt a child but were unsuccessful, the costs you incurred can be added to the cost of a subsequent successful attempt and then claimed for the year that adoption is final, or for the year after the year in which you incurred the expenses.

Foreign Adoptions: The rules covering foreign adoptions are a bit different. For example, credits can be claimed only after the adoption is final. Consequently, if you are unable to adopt, you may never claim the tax breaks on a foreign adoption. In addition, foreign children--regardless of any disabilities--are not considered special-needs children for the purposes of tax breaks. As a result, the maximum tax credit allowable for the adoption of a foreign child is $5,000, as is the maximum income exclusion.

Other Caveats: For tax break purposes, the child you adopt cannot be related to you. There are no credits for adopting a stepchild or a child conceived via a surrogate-parenting arrangement.

Moreover, the adoption tax credits are set to expire for tax year 2001. (A number of tax breaks have set expiration dates. Sometimes they are extended, but that depends on whether Congress can find the money to pay for the break in the future.) At that point, the credit would apply only to qualified expenses incurred when adopting a special-needs child.