Adoption credit and assistance exclusion.

• Author: Cvach, Gary Q.

Guidance on the new adoption provisions added by the Small Business Job Protection Act of 1996 (SBJPA) was issued recently in Notice 97-9.

Adoption Credit

Under Sec. 23, an individual can obtain an income tax credit for qualified adoption expenses paid or incurred in connection with the adoption of an eligible child. The maximum credit is $5,000 ($6,000 in the case of a "child with special needs"). The IRS defines an eligible child as an individual who, at the time the adoption expense is incurred, is (1) under 18 or (2) physically or mentally incapable of caring for himself. For qualified adoption expenses paid or incurred after Dec. 31,2001, an eligible child also must be a child with special needs.

A "child with special needs" is an otherwise eligible child who satisfies two additional requirements. First, a state must have determined that the child cannot or should not be returned to the parents' home and it must be reasonable to conclude that the child cannot be placed with adoptive parents without adoption assistance because of a specific factor or condition (e.g., a child's ethnic background, age, membership in a minority or sibling group, medical condition or handicap). Second, the child must be a citizen or resident of the U.S., including any U.S. possession.

Qualified adoption expenses include "reasonable and necessary adoption fees, court costs, attorney's fees, traveling expenses" and other expenses directly related to the adoption. An expense paid (by a cash-basis taxpayer) or incurred (by an accrual-basis taxpayer) in a tax year beginning before 1997 does not qualify.

The $5,000 or $6,000 limitation "is with respect to the adoption of each child and is cumulative over all taxable years (rather than an annual limitation)." The maximum amount includes qualified adoption expenses paid or incurred in any unsuccessful attempt to adopt an eligible child before successfully finalizing the adoption of another eligible child. The dollar limitation applies to both married individuals and unmarried individuals adopting an eligible child. Therefore, if an unmarried couple seeks to adopt a child, the $5,000 (or $6,000) dollar limitation would apply to the couple's combined qualified adoption expenses.

The credit is also subject to an income limitation. If the taxpayer's modified adjusted gross income (AGI) is $75,000 or less, the income limitation does not apply; if modified AGI is $115,000 or more, the credit is not available; if modified...