Federal Adoption Tax Credit

Adoptive parents may be able to claim a tax credit on their federal income tax return for qualified adoption expenses. This credit can be claimed even if the adoption has not been finalized, and even if the adoption process is interrupted and never finalized. This rule applies to domestic adoptions only; international adoptions must be finalized before you can apply the adoption tax credit. The expenses claimed for an adoption that is stopped are applied to the maximum amount that may be claimed on a second adoption.

The credit in 2004 is $10,390. For most adoptions, you may take as a tax credit the amount you actually spent on qualified adoption expenses, up to that limit. For adoption of a domestic waiting child (called a "special needs" child in IRS publications) you can take the full $10,390 as a tax credit, with no documentation needed as to the amount you actually spent. The same $10,390 is available for international adoptions (subject to the amount actually spent) after finalization. The tax credit limit is for expenses associated with each adopted child, rather than an annual limit.

The tax credit is progressively phased out for high-income families. In all cases, the adoption credit begins to phase out for taxpayers with modified adjusted gross income in excess of $155,860 and is completely phased out for those whose modified adjusted gross income exceeds $195,860.

This tax credit is more valuable than a tax deduction because allowable expenses are subtracted dollar for dollar against your tax liability. For example, if you owe $5,000 in federal taxes and have $3,000 in qualified adoption expenses, your tax bill is reduced to $2,000. If your tax bill is smaller than the credit, the unused portion of the credit may be carried forward for up to five years.

According to IRS Publication 968, qualified expenses include "reasonable and necessary" adoption fees, attorney fees, and some travel costs, including necessary transportation, meals, and lodging. Expenses related to surrogate parents or adopting a spouse’s child do not qualify for the credit. The credit also does not apply to expenses reimbursed by the government or private programs or for which an income tax deduction or credit already is allowed. Adoptive parents should carefully review the IRS guidance, preferably with a tax professional, to clarify what expenses qualify for the credit according to IRS guidelines.

What is the Hope for Children Act?
The Hope for Children Act (H.R. 622) is legislation which increases the adoption tax credit to $10,000 for all adoptions and increases the employer adoption assistance exclusion to $10,000. The Hope for Children Act is now public law which took effect on January 1, 2002. The Hope for Children Act was signed into law by President George W. Bush on June 7, 2001.

Do intercountry adoptions qualify for the adoption tax credit?
The Hope for Children Act applies to all adoptions—both domestic and intercountry. Like current law, in order to claim the tax credit for intercountry adoptions, the adoption must be finalized. For IR-3 visas, finalization usually occurs abroad. For IR-4 visas, finalization usually occurs in the United States.

How does the Hope for Children Act affect special needs adoptions?
The $6,000 adoption tax credit for special needs children is permanent law. However, the tax credit can only be utilized for qualified adoption expenses. While most special needs adoptions are from public agencies and do not have these up-front, ’qualified’ costs, the adopting families face other challenges in opening up their home to special needs children. Thus, the Hope for Children Act provides a flat $10,000 credit for special needs adoptions to help families with one-time and ongoing costs such as mental health counseling, physical therapy and medical costs, transportation costs, and home modifications to accommodate wheelchair ramps or large sibling groups. States have their own definitions of special needs children and use determining factors such as the child’s age, ethnic background, siblings, and mental, physical or emotional handicap. Note: While families adopting children with special needs can claim $10,000 in qualifying expenses beginning in 2002, they cannot claim the $10,000 flat credit until 2003.

Who should I contact for clarification on my particular tax credit scenario?
Contact the Internal Revenue Service at 1-800-829-1040 with your specific questions.

PLEASE NOTE: This information is provided as a general guideline on the new provisions of the adoption tax credit. It should not be used as a definitive source of information for individual case scenarios. The appropriate agency of the U.S. Government (e.g. the Internal Revenue Service or the U.S. Citizenship & Immigration Services) should be able to answer specific questions on the implementation of the Hope for Children Act.

The New Adoption
Tax Credit and You
by Adoptive Families
(PDF | 183Kb)

IRS Tax Topic 607
(weblink)