You may be able to take a new tax credit of up to $5,000 for qualifying expenses paid to adopt an eligible child. If expenses are for the adoption of a child with special needs, the credit can be as much as $6,000. The adoption credit is an amount subtracted from your tax liability. Through the year 2001, up to $5,000 ($6,000 for a child with special needs) paid or reimbursed by your employer for qualifying adoption expenses, may be excludable from your gross income. Although the credit generally is allowed for the year following the year in which the expenses were paid, a taxpayer who pays qualifying expenses in 1998 for an adoption which becomes final in 1998 may be eligible to claim the credit on the 1998 return.

Qualifying 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 and for which the principle purpose is the legal adoption of an eligible child. An eligible child must be under 18 years old, or physically or mentally incapable of caring for himself or herself. After 2001, the adoption credit applies only if the eligible child is a child with special needs. An eligible child with special needs is a U.S. citizen or resident who a state agency has determined should not or cannot be returned to the parents home and probably will not be adopted unless assistance is provided.

The credit and exclusion for qualifying adoption expenses are each subject to a dollar limit and an income limit.

Under the dollar limit the amount of your adoption credit or exclusion is limited to $5,000 for each effort to adopt an eligible child or $6,000 for each effort to adopt an eligible child with special needs. If you can take both a credit and an exclusion, this dollar amount applies separately to each.

The $5,000 (or $6,000) amount is the maximum amount of qualifying expenses taken into account over all taxable years. Therefore, it must be reduced by the amount of qualifying expenses taken into account in previous years for the same adoption effort.

The income limit on the adoption credit is based on your modified adjusted gross income (modified AGI). If your modified AGI is more than $75,000, the credit or exclusion will begin to be phased out. Once the modified AGI reaches $115,000 or more, the credit or exclusion will be eliminated.

You will figure these limits on Form 8839 Qualified Adoption Expenses, and attach it to Form 1040 or Form 1040A. The credit is reported on line 45 of the Form 1040 or line 30 of Form 1040A. Additional information for adopting U.S. and foreign children can be found in Publication 968, Tax Benefits for Adoption. The adoption credit or exclusion cannot be taken for a foreign child, (a child who is not a U.S. citizen or resident) unless the adoption becomes final. Employers should order Publication 968 to get information for an adoption assistance program and how to report this benefit.

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