As part of the Health Care Legislation passed earlier this year, the credit for expenses of adopting a child was increased and made refundable. Prior to this change, the credit was non-refundable and could only be used to reduce the adoptive parent’s tax to zero, with any unused portion of the credit carried over for up to five years and used against future years’ tax.

What this means is that taxpayers with unused adoption credit carryovers will be able to get the full benefit of those carryovers in 2010, and depending on the amounts of their tax and carryovers, reducing their tax to zero and a refund of any excess credit. Those who qualify for the credit in 2010 and 2011 also benefit from the new refundable provision, and any excess credit not used to reduce their tax for the year will be refundable.

The maximum amount of the credit was scheduled to drop to pre-2002 levels after 2010, but the reversion to the old law has been postponed until 2012, giving those who wish to adopt one additional year to take advantage of this substantial benefit at the higher amount.

For 2010, adoptive parents may be able to claim a credit against their federal tax for up to $13,170 of “qualified adoption expenses” for each adopted child. That's a dollar-for-dollar reduction of tax, the equivalent, for someone in the 25% marginal tax bracket, of a deduction of over $52,000. Where an adoptive parent’s employer has an adoption assistance program, the adoptive parent may exclude from their gross income up to $13,170 of qualified adoption expenses paid by an employer. Adoptive parents may claim both a credit and exclusion for expenses of adopting a child, but not the credit and exclusion for the same expense.

Qualified adoption expenses - Qualified adoption expenses include reasonable and necessary adoption fees, court costs, attorney fees, traveling expenses (including amounts spent for meals and lodging) while away from home, and other expenses directly related to the legal adoption of an “eligible child.”

Qualified adoption expenses don't include expenses connected with the adoption of a child of a taxpayer's spouse, expenses of carrying out a surrogate parenting arrangement, expenses that violate state or federal law, or expenses paid using funds received from a federal, state, or local program.

Expenses in connection with an unsuccessful attempt to adopt an eligible child before successfully finalizing the adoption of another child can qualify. Expenses connected with a foreign adoption (i.e., one in which the child isn't a U.S. citizen or resident) qualify only if the child is actually adopted.

Eligible child – Generally, an eligible child is under the age of 18 at the time the qualified adoption expense is paid. A child who turned 18 during the year is an eligible child for the part of the year he or she is under age 18. A person who is physically or mentally incapable of caring for himself is also eligible, regardless of age.

Credit phased out for higher-income taxpayers - The credit for 2010 is ratably phased out for taxpayers with adjusted gross incomes (AGI) over $182,520 and is completely phased out at $222,520.

If you are contemplating or in the process of an adoption and have additional questions or would like to determine how this credit will apply to your specific situation, please give this office a call. You may also be able to reduce your current withholding and/or estimated taxes based upon your credit carryover or 2010 credit.