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Vol.
71, No. 2, February 1998
Adoption Assistance
Offers Tax Relief
By Scott B. Franklin
Editor's Note: Links to I.R.S. forms and state statutes
in this article require you to install
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On Aug. 20, 1996, President Clinton signed into law the Small
Business Job Protection Act of 1996 (SBJPA). 1
As part of election year tax-relief measures, this legislation
made several refinements and
Adoptive parents incur additional
costs not faced by natural parents. Recent federal and Wisconsin
tax changes should help lessen the financial burden and encourage
more adoptions. |
improvements to the Internal
Revenue Code (Code), including the creation of a two-part
adoption assistance tax-relief program. The Wisconsin Legislature
also enacted adoption assistance during its 1996 session by reviving
a tax benefit that previously had been repealed
Federal Changes
Prior to the SBJPA, federal adoption assistance was limited
to an outlay program providing up to $1,000 of federal reimbursement
for expenses related to the adoption of children with certain
special needs. 2 Recognizing
the financial hardship caused by the adoption process, Congress
created both a tax credit and an income exclusion to help ease
the burdens of all adoptions.
Federal adoption assistance under the Code now is provided
by these two separate approaches. Using I.R.C. section 23, a taxpayer
may claim a nonrefundable tax credit on his or her income tax
return for qualified adoption expenses. 3
This credit directly reduces income taxes by an amount equal
to the allowed adoption expenses actually paid or incurred. Any
excess of allowed credit over tax due may be carried forward
and used within the next five years.4
Using section 137, the taxpayer may exclude from taxable income
amounts paid by his or her employer for such expenses. 5 This permits the taxpayer
to exclude from taxable income amounts paid pursuant to an employee
assistance program as reimbursement for allowed adoption expenses.
Provided that there are enough expenses so that none are counted
twice, the taxpayer may qualify under both provisions. 6 The statutory language of
each section is substantially identical with cross-references
between the two sections. 7
Benefits vary with adoptee's status and parents' income
The maximum tax credit or income exclusion available under
each section is $5,000 per adopted child. 8
The child must be under age 18 or otherwise unable to care for
himself or herself when adopted. 9
If a state certifies that a child should not be placed back into
his or her parent's home and the child requires assistance to
encourage placement due to age, ethnic background, medical or
emotional conditions or other factors, expenses of up to $6,000
per each special needs child are eligible for the new tax treatment.
10 However, a special
needs child must be a citizen or resident of the United States
for the adopting parents to qualify for the extra $1,000 benefit.
11
As with many tax benefits, the adoption tax credit and income
exclusion is phased out above a certain income level. A taxpayer
with adjusted gross income (AGI) less than $75,000 for the year
in which the credit or exclusion is claimed is eligible for the
full amount of the credit and/or exclusion. Between $75,000 and
$115,000 of AGI, the benefits are partially reduced. 12 By $115,000 of AGI, the
benefits under these sections are eliminated.
Qualified adoption expenses that may be claimed for the federal
tax credit or income exclusion are any reasonable and necessary
adoption fees, court costs, legal fees and other expenses directly
and principally related to the taxpayer's legal adoption of an
eligible child. 13If
the claimed expense is a capital improvement, such as a wheelchair
access ramp, the basis of the property is first increased by
the expenditure and then reduced by the credit or exclusion allowed.
14 The new law excludes
expenses incurred in violation of any state or federal law, in
connection with a surrogate parenting arrangement and in the
adoption of a spouse's child, such as in a second marriage.15
Timing is everything
The tax credit and income exclusion are available for expenses
paid or incurred after Dec. 31, 1996. 16
Except for expenses relating to the adoption of special needs
children, the tax credit expires for expenses paid or incurred
after Dec. 31, 2001; 17
the income exclusion will expire outright on this date. 18 Expenses reimbursed by
one's employer or the Federal Adoption Assistance program may
Qualified adoption expenses that
may be claimed for the federal tax credit or income exclusion
are any reasonable and necessary adoption fees, court costs,
legal fees and other expenses directly and principally related
to the taxpayer's legal adoption of an eligible child. |
not be claimed for the tax credit, 19
and any business owner with more than 5 percent ownership may
not receive more than 5 percent of the total benefits paid under
the company's adoption assistance program. 20
Special rules address the appropriate year in which to claim
the credit or exclusion. For the adoption of a child who is a
citizen or resident of the United States, the adoption credit
is claimed in the tax year following the year in which the expenses
are paid or incurred, except that the credit for expenses paid
or incurred during the year in which the adoption becomes final
is claimed in that year. 21
The income exclusion is taken in the year the employer pays expenses.
22 Internal Revenue
Service Notice 97-9 clarifies that the credit or exclusion also
may be claimed for an unsuccessful adoption attempt.23However, the expenses of
an unsuccessful adoption are added to those relating to a successful
adoption when considering the maximum benefit of $5,000 (or $6,000)
per adopted child. In the adoption of a foreign child, expenses
may be claimed for credit or exclusion only in the year a successful
adoption becomes final, even if paid or incurred earlier. 24 If the adoption is not
completed, the credit may not be claimed.
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