The Small Business Job Protection Act of 1996 included a new adoption tax credit to stimulate more adoptions and lessen the population of children in less secure foster care placement. The law allows married couples filing a joint return to claim a credit for “adoption expenses” for an eligible child (a person under 18 years of age unable to care for himself or her? self) through 2001. Since 2001, the credit has been limited to children “with special needs,” defined as a citizen or resident of the United States for whom the state has determined assistance is needed to effectuate an adoption—that is, someone the state cannot place. The credit is limited to necessary adoption fees, court costs, legal fees, and similar costs. It is not refundable; it may only be used to offset tax liability, and accordingly of no value to those who lack tax liability. A similar credit is available to an employer who pays such costs for an employee seeking to adopt.
The credit is limited to an income limit and a dollar limit. If any amount of qualifying expenses were taken into account in the past year for the same adoption, the dollar limit will be reduced by that amount. The income limit is based on the modified adjusted gross income (AGI). The credit will be reduced if the modified AGI exceeds that year’s beginning phase out amount. The credit will be eliminated if the modified AGI exceeds the maximum phase out amount for the year.
Many states have special needs adoption tax incentive programs of their own. For special needs adoption, the federal tax credit depends on several different factors. You can only receive a credit against taxes you actually pay. In other words, if you have incurred $6000 for adoption and you paid $7,000 in income taxes, you can get as much as $6,000 of that back in a credit. But if you only paid $3,000 in income taxes and had adoption expenses of $4,000, you will only be able to receive a tax credit of $3,000.
When you contact the IRS, ask for Publication 968, Tax Benefits for Adoption, and for Form 8839, Qualified Adoption Expenses, and for any other tax-related publications that are currently available. Get the latest information the IRS has to offer and save those adoption-related receipts. You can download forms from the IRS Web site.