What about Special Needs Children?

The tax credit for special needs children is the same as that for other children, with some added perks. For purposes of the tax credit, a special needs child is a child of any age who is a citizen or resident of the US and who has a “specific factor or condition, including ethnic background, age, membership in a minority or sibling group medical condition or physical, mental or emotional handicap,” for whom it is reasonable to conclude that the child cannot be placed with adoptive parents without providing adoption assistance.

This is the definition of a special needs child straight from the Internal Revenue Code. Practically speaking, there is a common understanding of factors that make a child a special needs child. The IRS definition is broader, though, and includes children who, for instance, might not be as adoptable because he or she is a member of a sibling group that should stay together.

Another added tax perk to adopting a special needs child is that the amount of expenses incurred by the adoptive parents in the year the adoption is finalized will be increased to the maximum even if the parents do not actually incur maximum expenses.

Example: Matt and Jenny finalize their adoption of Cindy, a child with Downs Syndrome, in 2009. In 2009, Matt and Jenny spent $8000 on adoption expenses. For 2009, Matt and Jenny will be allowed to claim a tax credit of $12,150. If Cindy were not a special needs child, Matt and Jenny’s tax credit would be limited to $8000, their actual expenses.

What else should you know?

The Adoption Expense Tax Credit is not refundable. This means that if adoptive parents end up with more credit in a given year than tax they owe, the excess cannot be refunded (unlike, for example, the earned income tax credit which is refundable). However, unused credit can be carried forward for up to five years.

Example: Matt and Jenny owe $5,000 in tax for 2009 and have an Adoption Expense Tax Credit of $10,000. Matt and Jenny’s tax liability for 2009 is reduced to $0 and they can carry forward the remaining $5,000 of tax credit to succeeding years. Thus, in 2010 Matt and Jenny had a tax liability of $8,000 which is reduced to $3,000 once the $5,000 of credit from 2009 is taken into account.

This credit is phased out for higher income taxpayers. For 2009, the phaseout begins (and thus the total credit available is reduced) starting at adjusted gross income of $182,180 and is completely phased out (and thus, the credit is not available) at adjusted gross income of $222,180. This is the income limit applied to both single and joint returns, however, married persons must file a joint return in order to claim the credit. This income limit does not reduce tax credits which are carried forward.

Example: Matt and Jenny have joint adjusted gross income for 2009 of $350,000. Matt and Jenny cannot claim a tax credit for adoption expenses paid in 2009. However, Matt and Jenny’s tax credit of $3,000 carried forward from 2008 can still be used to offset their tax liability for 2009.

Unmarried persons who incur adoption expenses for the same child must also abide by the applicable limit. They can divide the credit among themselves in any way they agree.

Example: Matt and James, a same-sex couple, adopt Cindy in 2009 and incur adoption expenses of $15,000 that same year. Although Matt and James will file separate 1040s for 2009, their cumulative adoption tax credit cannot exceed $12,150.

The expense limits of this credit are per child, not per placement. Thus, if adoptive parents seek to adopt two separate children during the same period, their maximum credit will also be doubled (in this case, from $12,150 to $24,300, and so on).

Clint Costa is an attorney and CPA with the Chicago law firm of Shaheen Novoselsky Staat Filipowski & Eccleston P.C., practicing in the areas of estate planning, business transactions and tax counsel.  Clint can be reached at (312) 621-4400 or by email at ccosta@snsfe-law.com.