Offering an Adoption Assistance Program

November 19, 2020

Each year in the United States, about 135,000 children join their forever families through adoption. However, adoption can be an expensive process. To create a family-friendly environment and maintain a competitive benefits package, employers can offer adoption assistance to their employees. Adoption benefits typically include a combination of financial assistance, information and referral services, and paid or unpaid leave.

Adoption benefits are low cost and high impact. Few employees actually use adoption benefits, keeping employers' costs low, but the goodwill between employers and employees derived from offering the benefit is significant:

  • Creates a positive perception of the company as being sensitive to employees' needs and supportive of adoptive families
  • Workers who use adoption benefits often feel greater loyalty to their employer
  • Employees who don’t use the benefits still view their employer positively for offering them
  • Provides a competitive edge in recruiting new employees

An Adoption Assistance Program (AAP) is a voluntary employer-sponsored program that financially assists or reimburses employees for expenses related to the adoption of a child. An AAP is a formal, written plan maintained by an employer, who determines:

  • Whether the adoption assistance policy will apply only to employees who finalize an adoption, or also to those with unsuccessful adoption efforts
  • The amount of financial assistance and/or paid leave
  • Employee eligibility requirements

An AAP must meet these requirements:

  • Must benefit all eligible employees, not just “highly compensated”
  • Must not pay more than five percent of its benefits to shareholders or owners (or their spouses or dependents)
  • Employer must give reasonable notice of the plan to eligible employees
  • Employees must provide reasonable substantiation that payments or reimbursements are for qualifying expenses

The core of most AAPs is financial assistance. The amount of coverage extended to employees varies, but the goal is to reimburse employees for certain expected adoption-related expenses.

Qualified adoption-related expenses include:

  • Reasonable and necessary adoption fees (e.g., adoption agency or foreign adoption fees)
  • Court costs and attorney fees
  • Travel expenses (e.g., meals and lodging while away from home)
  • Other expenses that are directly related to and for the principal purpose of the legal adoption of an eligible child (an individual who is under the age of 18 or is physically or mentally incapable of self-care)

An expense may be qualified even if paid before an eligible child has been identified. For example, prospective adoptive parents who pay for a home study at the outset of an adoption effort may treat the fees as qualified adoption expenses.

An AAP can be offered as an employer-sponsored stand-alone benefit or as part of a cafeteria plan.

Stand-Alone

An AAP offered as a stand-alone employer-provided program is subject to dollar and income limits and to other requirements of IRS Code §137. A qualified adoption assistance program is not required to be funded. As a non-ERISA plan, there is no requirement under ERISA to hold program monies in trust.

Most employers cap the AAP benefit dollar amount regardless of actual expenses. This varies among employers; the range is from $5,000 to $20,000 per adoption.

Cafeteria Plan

An AAP can allow employees to set aside funds on a pre-tax basis to pay for adoption-related expenses through a cafeteria plan, provided the plan document is drafted to permit it. Establishing an adoption assistance Flexible Spending Account (FSA) under a cafeteria plan would cause general FSA rules to apply. The FSA “use-or-lose” rule means adoption assistance contributions would be forfeited if not used to pay expenses incurred during the plan year (or during the grace period, if applicable). Unused amounts remaining in the adoption assistance FSA may not be carried over to pay or reimburse expenses incurred in a subsequent plan year. Adoption assistance amounts paid under a cafeteria plan may be excludable from an employee’s income, and an employee receiving adoption assistance must claim the income exclusion by filing IRS Form 8839 with their income tax return.

Adoption assistance programs provided through an employer-sponsored plan allow employees to exclude up to $14,440 from their taxable income in 2021. The income exclusion begins to phase out for taxpayers with incomes in excess of a specified amount that also changes every year.

An adoption assistance account must be elected during annual benefits open enrollment. Employees choosing to take advantage of an adoption assistance account should be vigilant in understanding when services will be provided before making an election.

An AAP provides tax benefits.

Tax benefits for adoption include both the exclusion from income for an employer-provided AAP and a federal tax credit for qualified adoption expenses. In some cases, using both an adoption assistance account and the adoption tax credit are possible. Employers that offer adoption assistance and employees who take advantage of it—or who claim the adoption tax credit—must be aware of legal contribution limits and changes in tax laws that affect adoption. Seek professional tax advice and find details on the IRS website at https://www.irs.gov/taxtopics/tc607

Chard Snyder administers adoption assistance FSAs and we would be happy to assist you if you choose the cafeteria plan option for your employee Adoption Assistance Program. Contact your Chard Snyder Client Relationship Manager for more information.