Exploring Adoption Assistance Programs

May 1, 2025

Caitlin Hillenbrand, Associate Director, Benefits Compliance

An increasing number of companies are integrating adoption assistance benefits into their employment benefits packages in recent years. Offering an adoption assistance program has many benefits, including improving employee retention and satisfaction, ensuring that employees who adopt receive similar benefits to those who have biological children, attracting and retaining talent, showing support for the different paths to parenthood and family-building, and enhancing company image by projecting a caring, family-friendly image. This article delves into adoption assistance programs, as well as the legal and tax considerations tied to these benefits.

Employer Action Items

If employers choose to incorporate adoption benefits into their packages, the following are some key steps they could consider:

• Research Adoption Assistance Programs: The employer should understand what adoption assistance programs often include. Typical features might encompass financial reimbursement, paid leave, and resources and referrals for adoption services.
• Consult with Legal and Financial Advisors: It’s crucial to be aware of the legal, tax, and financial implications of offering such benefits. Depending on the specifics of the benefits offered, there may be different obligations or potential benefits for the employer.
• Develop a Written Policy: This should clearly set out eligibility requirements, the specific benefits included, any monetary caps on benefits, and procedural requirements for requesting and approval of these important benefits.
• Evaluate Current Benefits Policies: The new adoption benefits should be integrated seamlessly with existing benefits. The employer should consider how the adoption benefit interacts with other benefits like FMLA, short-term disability, and/or paid leave policies.
• Communicate the Benefit to Employees: Assure that employees are aware of this important benefit and understand how to access it. This might be achieved through email communications, informational advisory meetings, or updates to the employer’s employee benefits guide or its employee handbook.
• Plan to Review the Benefit Regularly: As with any benefit, changing circumstances may necessitate updating the adoption benefit. The employer should periodically review the policy to ensure it remains competitive and is administered in accordance with legal and financial requirements and administrative best practices. Note, these are general steps and might not cover all aspects of launching a specific adoption assistance program within a particular organization. Always consult with HR and legal experts during the process.

Summary

Established under Internal Revenue Code (“I.R.C.”) Section 137, a qualified adoption assistance program may be offered as a flexible spending account within a cafeteria plan or outside such an arrangement. Funding for an adoption assistance program may come from the employer, the employee, or both, using pre-tax dollars from the employee. This type of program allows employees to exclude reimbursements for adoption-related expenses from their gross income. Additionally, employers can offer paid or unpaid leave on top of what is mandated by state or federal law.

Adoption assistance programs have certain restrictions respecting plan-level participation. Specifically, former employees and self-employed individuals, which include partners and shareholders with more than 2% stake in an S Corporation, are not eligible to participate. Accordingly, the employer will have to take the following steps as a matter of plan design:

• Set the criteria for employee eligibility;
• Determine the extent of financial aid; and,
• Decide if the adoption assistance program might apply solely to employees who complete the adoption procedure, or if it shall also cover employees who experience unsuccessful attempts at adoption proceedings.

A qualified adoption assistance program requires a written plan document and must satisfy the following regulatory standards:

• Employees must reasonably substantiate that any payments or reimbursements received from the program are for legitimate adoption expenses;
• All eligible employees must benefit from the program, not exclusively those who are “highly compensated”;
• Employers must not allocate more than 5% of the program’s benefits to shareholders, business owners or their spouses, or dependents; and,
• Employers are obligated to adequately inform eligible employees about the plan.

While the objective of the program should be to provide employees with benefits for adoption assistance, interestingly, I.R.C. § 137 does not define adoption assistance. Despite the lack of an explicit definition, the program should be limited to paying or reimbursing “qualified adoption expenses”. That term is defined to mean reasonable and necessary adoption fees, court costs, attorney fees, and other expenses:

1. Which are directly related to, and the principal purpose of which is for, the legal adoption of an eligible child by the taxpayer;
2. Which are not incurred in violation of State or Federal law or in carrying out any surrogate parenting arrangement;
3. Which are not expenses in connection with the adoption by an individual of a child who is the child of such individual’s spouse; and,
4. Which are not reimbursed under an employer program or otherwise (see I.R.C. § 23(d)(1)).

Tax Implications

Adoption assistance related tax benefits encompass a tax credit for valid adoption expenses incurred in adopting an eligible child, as well as an income exclusion for adoption assistance provided by employers through an authorized adoption assistance program. The IRS permits employers to exempt from federal income tax withholding the entirety or a portion of reimbursements and payments made to or on the employees’ behalf participating in the adoption assistance program. However, these payments remain subject to Medicare, Social Security, and Federal Unemployment Tax Act (FUTA) taxes, as detailed in IRS Publication 15-B. They may also be susceptible to state and/or local taxes.

A tax exclusion is available for employees who receive adoption assistance from their employer. Up to a certain limit, employees are not taxed on employer-provided adoption assistance, unless they have a modified adjusted gross income (or modified AGI) above a certain threshold:

• For taxable years beginning in 2024, the excludable amount is $16,810. The excludable amount begins to phase out for those with a modified AGI above $252,150 and is completely phased out for those with a modified AGI of $292,150 or more; and,  
• For taxable years beginning in 2025, the excludable amount is $17,280. The excludable amount begins to phase out for those with a modified AGI above $259,190 and is completely phased out for those with a modified AGI of $299,190 or more.

Additionally, any taxpayer who adopts a child is eligible for a nonrefundable tax credit for each eligible child in the same amount as the tax exclusion.

• For taxable years beginning in 2024, the maximum credit allowed is $16,810. The income tax credit must arise from expenses the employee paid out-of-pocket that were not refunded by the employer. For 2024, the excludable amount begins to phase out for those with a modified AGI above $252,150 and is completely phased out for those with a modified AGI of $292,150 or more.
• The maximum credit allowed is $17,280 for taxable years beginning in 2025. The excludable amount begins to phase out for those with a modified AGI above $259,190 and is completely phased out for those with a modified AGI of $299,190 or more.

Employees have the opportunity to benefit from both the tax credit and the tax exclusion for employer reimbursements, although the same costs cannot be claimed for both purposes. Employees must first utilize any permitted exclusion before making a claim for any permitted credit. Any expenses used for the exclusion will reduce the total amount of qualified adoption expenses that can be used for the credit.

Employers are required to report on each employee’s Form W-2 the total amount of adoption assistance paid by the employer (or the total expenses incurred by the employer on any employee’s behalf). Since these adoption assistance benefits are subject to taxes under the Federal Insurance Contributions Act (“FICA”), employers are also obligated to report them as wages for purposes of Social Security and Medicare taxes on the Form W-2.

In order to qualify for either the income exclusion or the tax credit, the child being adopted must meet the criteria for an “eligible child” and the incurred costs must be recognized as “qualified adoption expenses”. An eligible child is defined as one who is below the age of 18 at the time of adoption, or who is physically or mentally incapable of self-care.

Nondiscrimination Rules

Adoption assistance programs are subject to the following I.R.C. §129 nondiscrimination rules:

• Eligibility Test: The program should benefit employees who qualify under a classification that does not favor highly compensated employees or their dependents; and,
• Concentration Test: Those who own more than 5% of the stock, capital, or profit interest in the employer, including their spouses and dependents, cannot receive more than 5% of the total benefits from the program.

Please note that these tests apply regardless of whether the program is offered through a cafeteria plan. If the program is provided through a cafeteria plan, it also has to meet the three nondiscrimination tests (eligibility, contributions and benefits, and key employee concentration) as per the rules for cafeteria plans under I.R.C. §125).

Conclusion

Offering adoption benefits can be advantageous to your current employees and can also be a compelling incentive in attracting new employees. Given the potentially high costs, complexity, and time-consuming nature of adoption, prospective employees who are considering adoption may be drawn to a company that supports the process over those that do not. Therefore, it is worthwhile to consider whether providing adoption benefits is a feasible opportunity for your organization.

Additional Information & Resources

• https://www.irs.gov/credits-deductions/individuals/adoption-credit
• https://www.childwelfare.gov/resources/states-territories-tribes/
• https://www.law.cornell.edu/uscode/text/26/137
• https://www.law.cornell.edu/uscode/text/26/23