Iowa has a new tax credit available for adoptions. I wrote about this on April 1st.
A question I had about the credit was: how does this credit relate to the federal adoption credit for special-needs adoptions?
On federal tax returns, the adoption credit is limited to actual, unreimbursed, expenses incurred in adopting a child.
There’s one exception to this, and that is a special-needs adoption. Here’s the definition of a “special-needs child” from the IRS:
A child is a child with special needs if all three of the following statements are true.
The child was a citizen or resident of the United States or its possessions at the time the adoption effort began (U.S. child).
A state (including the District of Columbia) has determined that the child cannot or should not be returned to his or her parents’ home.
The state has determined that the child will not be adopted unless assistance is provided to the adoptive parents. Factors used by states to make this determination include:
a. The child’s ethnic background and age,
b. Whether the child is a member of a minority or sibling group, and
c. Whether the child has a medical condition or a physical, mental, or emotional handicap.
(From the instructions to Form 8839)
A special-needs adoption automatically qualifies for the maximum adoption credit ($13,190 on 2014 tax returns) regardless of the amount actually spent on the adoption.
How Does This Affect the Iowa Credit?
The Iowa adoption credit is available for qualifying expenses up to $2,500. Expenses beyond $2,500 may be eligible for an itemized deduction in Iowa. See my prior post linked to above for more details.
When it’s a special-needs adoption, does the taxpayer automatically qualify for a $2,500 deduction, plus a deduction for the remaining $10,690 ($13,190 – $2,500)?
The answer is NO! The Iowa adoption credit is based on actual expenses ONLY.
John and Joan adopt a special-needs child. Their only expenses are $1,500 of attorney fees. On their federal tax return, they can claim the full $13,190 adoption credit because it was a special-needs adoption. But on their Iowa tax return, the credit is limited to $1,500 because that’s what they actually spent on the adoption.