Adoption Tax Credit for Expenses Also Applies When Attempt Fails

The Internet twins--a widely publicized case in which a set of twins was promised to two couples who each paid substantial adoption fees--brought public attention to a little-discussed topic: the cost of failed adoptions.

Richard and Vickie Allen of San Bernardino and Alan and Judith Kilshaw of Wales are perhaps the best-known would-be adoptive parents, but 5% to 50% of attempted adoptions are never completed, experts say.

The federal tax code, which provides tax breaks for people who adopt, does the same in cases in which an adoption falls through. However, most adoption tax credits are set to expire at the end of the year and efforts to extend them have proved unsuccessful.

That’s bad news for people such as Jenny and Reed Kaltenbach. The West Texas couple, who have an adopted son, paid $9,000 in legal fees and medical expenses to adopt a second baby--but the birth mother disappeared shortly before the baby was due.

When the Kaltenbachs attempted to claim an adoption tax credit on their 2000 return, their tax accountant and several other experts told them they couldn’t claim this special tax break that allows taxpayers to recoup some of the expense of adopting a child. Why? It could be claimed only for a completed adoption, they were told.

But the IRS says that is incorrect. Even if a domestic (as opposed to foreign) adoption falls through, you can claim a tax credit of up to $5,000, said Don Roberts, an IRS spokesman in Washington.

“Even if an adoption never becomes final, but you spent money in the attempt, you can claim the expenses in the year after they are incurred,” Roberts said.

As is evident by the faulty advice the Kaltenbachs received, adoption credits are complicated. Moreover, they’re changing in ways that prospective adoptive families need to understand. Here’s a look:

* The basics: Adoptive parents who meet certain income restrictions can claim a tax credit of up to $5,000 per adoption to recover related out-of-pocket expenses. Those who adopt a special-needs child--one who has disabilities, is older or is otherwise considered hard to place--can claim a tax credit of up to $6,000 per adoption.

(Tax credits reduce your federal income tax on a dollar-for-dollar basis, making them more valuable than tax deductions, which simply reduce your taxable income.)

In addition, if your employer offers adoption assistance such as counseling or employer-paid travel, up to $5,000 of this assistance can be excluded from your income ($6,000 for a special-needs child). However, the tax breaks can’t exceed the amount of qualified expenses.

* Qualified expenses: These can include everything from attorney fees and court costs to travel expenses and fees paid to government offices that facilitate the adoption. The credit even covers the cost of home improvements required for the new family member, such as a ramp or an elevator for a child in a wheelchair.

The credit also can offset medical expenses the adoptive parents pay on behalf of the birth mother, where allowed. However, any expense that violates a state or federal law--a few states ban payments to birth mothers--do not qualify for a credit.

Naturally, you can’t claim tax credits for expenses that were reimbursed.

* Income phaseouts: The credit begins to phase out for parents earning more than $75,000 annually and is eliminated at the $115,000 level. The income restrictions are the same for married and single.

* Claiming adoption credits: The tax credit generally is claimed in the year that the adoption becomes final or in the year after the expenses are incurred.

To claim the credit, you must fill out form 8839 to document that the adoption was completed. You will be asked to supply the court decree that grants you custody of the child, the child’s Social Security number and/or hospital certification showing that you took the child from the hospital.

* Failed adoptions: In cases of failed adoptions such as the Kaltenbachs’, taxpayers can claim the credit by filling in what they know--which may be only the name and address of the adoption agency or attorney hired to help with the adoption, as well as details about the expenses incurred, Roberts said.

One caveat: This holds true only for domestic adoptions. You cannot claim any tax credits for a failed adoption in another country.

* Limitations: If the Kaltenbachs adopt another child, any portion of the credit they claimed for the failed adoption will be deducted from what they can claim for their completed adoption, said Mark Luscombe, principal tax analyst with CCH Inc., a publisher of tax information based in Riverwoods, Ill.

* Coming changes: Starting next year, tax credits for adoptions, successful and failed, will be available only in special-needs cases. Private adoptions of healthy children generally will not qualify for any tax credit. That’s because the adoption tax credit, which was passed as part of minimum wage legislation in 1996, was a temporary measure and expires Dec. 31.

There have been several attempts to maintain the credit and boost it. For example, bills were introduced this year in the House and Senate to make the adoption credit permanent and larger, allowing credits for up to $10,000 in expenses. It’s uncertain whether a measure now under consideration in the House will pass as proposed--or at all. However, adoption credits have widespread popular support.

* Grace period: If the adoption-credit bill doesn’t pass, you still can claim a credit for expenses incurred this year--even if the adoption isn’t completed until 2002, Roberts said.

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Times staff writer Kathy M. Kristof, author of “Investing 101” (Bloomberg Press, 2000), welcomes your comments and suggestions but regrets that she cannot respond individually to letters or phone calls. Write to Personal Finance, Business Section, Los Angeles Times, 202 W. 1st St., Los Angeles, CA 90012, or e-mail kathy.kristof@latimes.com. For past Personal Finance columns visit The Times’ Web site at https://www.latimes.com/perfin.