Legislation awarding tax credits and tax exemptions to adoptive families became law on August 1, 1996 as part of the "Small Business and Job Protection Act" (H.R. 3448) that raised the minimum wage. The tax provisions contained in the law are similar to those in the "Adoption Promotion and Stability Act" (H.R. 3286) passed by the House on May 10, 1996. The new law included the following provisions:

Amount of Credit

The law provides a tax credit of up to $5,000 for expenses incurred or paid in the adoption of a child, or $6,000 involved in the adoption of a child with special needs. Step-parent adoptions do not qualify for this tax credit. Families with annual adjusted gross incomes under $75,000 would be eligible for the full tax credit, while those with incomes between $75,000 and $115,000 could receive a partial tax credit. Families with an adjusted gross income of over $115,000 are not eligible for this tax credit.

If a family's tax bill is less than its adoption expenses, the difference could be deducted from future tax bills. The tax credit could be carried forward in this manner for a maximum of five years. Suppose the Weller family incurs expenses of $10,000 in relation to the adoption of a child with special needs. The family earns $60,000 in 1997 and owes $2,000 in federal taxes. The $6,000 tax credit could be applied, reducing the 1997 tax bill to zero, and the remaining $4,000 could be carried forward into future tax years. Eligible Expenses

The new law defines qualified expenses as "reasonable and necessary fees, court costs, attorney fees, and other qualified expenses which are directly related to the legal adoption of adoption of an eligible child by the taxpayer." The list of eligible costs for special-needs adoptions includes "construction, renovations, alterations, or purchases specifically required... to meet the needs of the child." Name, age and taxpayer ID number for the child are required for the credit.

Employer-Provided Assistance

Employers are no longer required to withhold income tax from adoption reimbursements. These reimbursements, as well as grants or federal, state or local government programs, are ineligible for the tax credit. Employer reimbursements for adoption expenses become non-taxable income to the employee. The maximum amount of reimbursement excluded is $5,000 per child ($6,000 for special-needs adoption); it includes the same expense eligibility and income phase-out as the tax credit. Name, age and taxpayer ID number for the child are required for both the credit and the exemption. An individual may claim both a credit and an exemption in connection with the adoption of an eligible child, but may not claim the same expenses twice.

Tax Year and Time Limits

The adoption tax credit and tax exemption for employer-paid adoption assistance begins with the 1997 tax year. Unlike H.R. 3286, the new law ends the tax credit and tax exemption for all but special-needs adoptions by December 21, 2001.

The tax credit and exemptions apply to the taxable year in which the adoption is finalized. Adoption expenses paid or incurred in 1998, for example, would apply to the 1999 tax year if the final decree of adoption was issued in that year. Costs incurred in late 1996, however, will not apply to 1997, the year the law takes effect.

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