Home / Blog / Core Documents Adds Section 137 Adoption Assistance Plan Document for just $99

Core Documents Adds Section 137 Adoption Assistance Plan Document for just $99

Bradenton, FL – Gene C. Ennis – February 12, 2015: Core Documents, the nation’s leading provider of affordable Section 125 Cafeteria and HRA Plan Documents has just added a new Plan Document option, the Section 137 Adoption Assistance Plan.

Core Documents provides employers with everything they need to establish an IRS-compliant Section 37 Adoption Assistance Plan in PDF form for just $99. This cost reflects a one-time setup fee, not an annual charge. For an additional $50, employers can choose the Deluxe Binder option, which includes an PDF email version plus a printed plan document in a 3-ring binder.

Until we get a new online order form completed simply use our basic $99 Section 125 online order form. Please add special Adoption Assistance plan design instructions in the notes area. Or, call 1-888-755-3373 and a benefit coordinator will be happy to help you and take your order by phone.

2014 Indexed Maximum Adoption Tax Credit $13,190

For 2014, the maximum aggregate amount per child that an employer can provide an employee for adoption assistance under IRC Sec. 137(a)(2) or that an employee can claim for an adoption tax credit is $13,190. The available adoption limit begins to phase out for employees with a modified adjusted gross income in excess of $197,880 and phases out entirely for employees with modified adjusted gross income of $237,880.

How does the tax code treat adoption assistance benefits?

An employee can get a tax credit up to $13,190 for qualified adoption expenses. Alternatively, an employee can exclude from income up to $13,190 in payments and reimbursements received from his or her employer for qualified adoption expenses. This favorable tax treatment is permitted by Section 137 of the tax code, which was created in 1996. In addition, an employer can provide adoption assistance reimbursements as qualified benefits under a cafeteria plan, thereby allowing employees to benefit from favorable tax treatment with no direct cash outlay by the employer.

How does employer-provided adoption assistance qualify for favorable tax treatment?

To qualify for favorable tax treatment under Section 137, employer-provided adoption assistance must meet four requirements:

1. The assistance must be provided under a “separate written plan” (although the plan does not have to be funded). Although Section 137 does not describe what a separate written plan should look like, IRS regulations under Code Section 127 (which governs educational assistance plans) provide a reasonable model for what should be acceptable for adoption assistance plan documents.
2. The plan must be limited exclusively to employees of the employer.
3. Employees who are eligible to participate must receive reasonable notice about the availability and terms of the written program.
4. Except for the adoption of a child with special needs (for which expenses need not be incurred to receive reimbursements), employees who receive payments under an adoption assistance program must provide the employer with reasonable substantiation that payments or reimbursements under the program are for qualified adoption expenses.

In what instances can adoption assistance benefits result in taxable income?

An employer is required to treat as taxable income any unsubstantiated expenses, excess reimbursements or benefits provided under an adoption assistance plan that fails to meet the Section 137 qualification requirements described above.

How is adoption assistance to members of the Armed Services handled?

Adoption assistance programs provided to members of the armed services and the Coast Guard are automatically treated as qualified adoption assistance programs. They do not have to meet the plan qualification requirements under Section 137.

What kinds of adoptions qualify under an adoption assistance plan?

Three kinds of adoptions are eligible for tax-favored reimbursement or payments through an employer-provided plan: domestic adoptions, foreign adoptions and adoptions of “special needs” children. All three are described below.

(1) Domestic adoptions. In a domestic adoption, an eligible child is any individual who, at the time the expenses are paid or incurred, is under the age of 18 or is physically or mentally incapable of caring for himself or herself. The Section 137 rules do not distinguish between state-licensed agency adoptions and private legal adoptions. Amounts are excludable for the year in which the employer pays the adoption expenses. A domestic adoption does not have to be finalized in order to qualify for adoption assistance reimbursements.

(2) Foreign adoptions. Employer-provided assistance for an international adoption (referred to as a “foreign” adoption by the IRS) is excludable from income only if the adoption is considered “final.” Under a February 2003 IRS notice, a final adoption occurs when a foreign-born child receives one of four different types of “Immediate Relative” (IR) visas from the Immigration and Naturalization Service (INS). In general, depending on the IR category, the adoption is final in the tax year in which either the country of origin entered the adoption decree or when the adoptive parents’ home state recognizes the adoption decree.

Also, any expenses incurred before the year the adoption is finalized are treated as being paid in the year the adoption is finalized. Consequently, if an employer reimburses expenses before the year the adoption is finalized, the reimbursement must be included in income for the year it is reimbursed. Subsequently, the amount can be excluded in the year the adoption is finalized.

(3) “Special needs” children. To qualify as a child with special needs, the state must have determined that: (a) the child cannot or should not be returned to the parents; and (b) due to special factors, the child cannot be placed without adoption assistance. In addition, the child must be a citizen or resident of the United States.

Examples of such special factors include a child’s ethnic background, age, membership in a minority or sibling group, medical condition or disability. The exclusion is available to adoptive parents who adopt a child with special needs, even though the adoptive parents do not incur any expenses. However, these “deemed expenses” ($13,190 minus the total actual qualified expenses) are not treated as having been incurred until the year the adoption is finalized. Federal grants are available to cover certain expenses of adopting a child with special needs, but expenses covered by such grants do not qualify for tax-free reimbursements or credits.

 What kinds of adoptions do not qualify?

Expenses covered by employer reimbursements or payments for the following types of adoptions are not excludable from gross income under Section 137 Adoption Assistance Plans:

• an illegal adoption;
• an adoption through any surrogate parenting arrangement;
• the adoption of a stepchild; and
• the adoption of an adult (age 18 or older) who can take care of himself or herself.

What are “qualified” adoption expenses?

Qualified adoption expenses include, but are not limited to, 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 whose principal purpose is for, the legal adoption of an eligible child. The same standards apply for purposes of the adoption tax credit under Section 23.

What kinds of expenses are not qualified?

Qualified adoption expenses do not include those that:

• violate state or federal law;
• are for a surrogate parenting arrangement;
• are for adopting a stepchild;
• are paid using funds received from a local, state or federal program or other source; or
• are allowed as a credit or deduction under another federal income tax rule.

What can an employer exclude from an adoptive parent’s gross income?

The employer can exclude reimbursements for qualified adoption expenses and reasonable and necessary expenses directly related to a legal adoption. There are two limitations on the amount of any excludable reimbursement — a dollar cap and an income limitation. (These are described in the next two questions.) In addition, for adoption assistance benefits to be excludable, the benefits must meet the Section 137 plan qualification requirements and IRS nondiscrimination requirements.

How does the dollar cap work?

Under Section 137, up to $13,190 of adoption expenses (adjusted annually to account for inflation) may be reimbursed on a tax-favorable basis (that is, excludable from income).

This cap applies to each eligible adoption, regardless of how many years it takes to adopt the child. It is not an annual limit. Thus, it appears that more than one child may be adopted in the same year, and that up to $13,190 of adoption assistance could be provided on an excludable basis for each adoption. If a child is adopted after other unsuccessful adoption attempts, the IRS maintains that the expense reimbursements for the other unsuccessful attempts are counted toward the $13,190 cap for the successful adoption.

The same $13,190 cap applies regardless of whether a married couple, an unmarried couple or a single individual adopts a child. This means that an unmarried couple that adopts a child must apply the dollar cap to their combined expenses.

How does the income limitation work?

The available adoption limit begins to phase out for employees with a modified adjusted gross income in excess of $197,880 and phases out entirely for employees with modified adjusted gross income of $237,880.

How is adoption assistance offered through a cafeteria plan?

Under a cafeteria plan, an employee elects to have a specified dollar amount of wages or salary reduced (that is, withheld before taxes) and credited to an unfunded spending account that is used to reimburse the employee’s qualified adoption expenses. This salary reduction election should be made before the plan year in which adoption expenses are incurred. The amount of the salary reduction is not subject to either income tax withholding or Social Security and Medicare (FICA) taxes. The employee then applies for reimbursement of eligible adoption expenses paid or incurred during the year, drawing down the spending account.

Although the salary reduction amounts contributed to the spending accounts are exempt from income tax withholding and FICA taxes (see above), reimbursements from them are subject to FICA taxes. Reimbursements are also exempt from income tax withholding (unless the plan or the employee fails to comply with the Section 125 or Section 137 requirements).

If a domestic adoption involves a child with special needs, the exclusion is available to the parents even if they have not actually incurred any adoption-related expenses. These so-called “deemed expenses” ($13,190 minus the total actual qualified expenses) are not treated as having been incurred until the year the adoption is finalized.

For a foreign adoption, any reimbursements of adoption expenses from the cafeteria plan before the adoption is finalized must be included in income and are subject to income tax withholding and FICA taxes. The reimbursement amounts are subsequently excludable from income in the year the adoption is finalized. Employers should alert employees about this in the materials that accompany their cafeteria plan election forms.

Can I “carry over” unspent cafeteria plan funds from one year to the next?

No. Under the “use-it-or-lose-it” rule that applies to cafeteria plans, salary reduction contributions made in one plan year cannot be used in a subsequent plan year. Thus, any employees who participate in an adoption assistance program through a cafeteria plan must make sure that any salary reduction contributions to the cafeteria plan earmarked for adoption assistance are used before the end of the plan year in which they are made. For the adoption of a child with special needs, the “deemed” qualified adoption assistance expenses ($13,190 minus the actual aggregate adoption assistance expenses) are treated as having been incurred in the year the adoption is finalized, so special care must be taken to ensure that the salary reductions and the finalization of the adoption occur in the same year.

What nondiscrimination rules apply to adoption assistance plans?

Adoption assistance programs are subject to nondiscrimination rules similar to the nondiscrimination rules applicable to educational assistance programs under Section 127 of the tax code — that is, the “eligibility” and “concentration” tests. (See the next two questions.) Failure to meet the nondiscrimination requirements means that benefits provided under the plan to all employees must be treated as taxable income.

The IRS has not issued any guidance explaining the application of these two nondiscrimination tests to adoption assistance programs. However, it is likely that any future rules governing adoption assistance plans will be similar to the Section 127 nondiscrimination rules, which are described below. (Note that these complex rules are described in greatly simplified terms. Conducting the tests requires a more detailed explanation.)

What is the eligibility test?

Under the eligibility test, adoption assistance programs must be offered to a class of employees that does not discriminate in favor of officers or shareholders of the employer, self-employed individuals or highly compensated employees (HCEs). Under Section 414(q) of the tax code, an employee is generally considered an HCE if at any time during the preceding year, he or she:

1. was a 5-percent owner of the employer;
2. received more than $80,000 in compensation (inflation-adjusted to $90,000 in 2002 and 2003); or
3. was in the employer’s “top-paid group” (that is, active employees in the top-paid 20 percent of the workforce) and met the standard in item (2).

Generally, nondiscrimination in eligibility must be determined using the complicated “fair cross-section test” applicable to cafeteria plans and other benefits) under Code Section 410(b).

What is the concentration test?

Under the concentration test, a shareholder or owner (someone who owns on any day of the year more than 5 percent of the employer’s stock, capital or profits interest), or the spouse or dependent of a shareholder or owner, may not receive more than 5 percent of the adoption assistance benefits provided during any year. Because of this test, these individuals should generally be excluded from participating in a qualified adoption assistance plan.

How should an employer report adoption assistance benefits to the IRS?

An employer must report on employees’ W-2 forms the total assistance amount the employer paid (or the total expenses the employer incurred) on behalf of each benefiting employee. This amount is reported in Box 12 of the W-2 form, using Alpha Code “T.” Do not report qualified adoption assistance benefits as wages in Box 1. The reported total in Box 12 (but not Box 1) should include benefits paid from a cafeteria plan account attributable to an employee’s pretax contributions.

Because adoption assistance benefits are subject to FICA taxes, employers also must report them as wages in Box 3 (for Social Security tax purposes) and Box 5 (for Medicare tax purposes) of the Form W-2. The annually adjusted Social Security wage base cap ($87,000 in 2003) applies to the amount reported in Box 3.

Should adoption assistance benefits be reported on the Form 5500?

Section 6039D of the tax code requires employers to file annual information returns with respect to adoption assistance programs qualifying under Code Section 137. In 2002 the IRS suspended the requirement that a Form 5500 and Schedule F must be filed with the IRS with regard to adoption assistance programs, pending the IRS’ evaluation of the Code Section 6039D information reporting requirement.

When should an employee claim the tax credit for adoption expenses?

The year in which an employee can claim the $13,190 tax credit for adoption-related expenses under Section 23 depends on three things: (1) whether the adoption is domestic or foreign; (2) whether the expenses are paid or incurred before or after the adoption is finalized; and (3) whether the adoption is for a child with special needs.

If a domestic adoption is not final, an employee should claim a tax credit for qualified adoption expenses in the tax year following the year in which he or she paid or incurred the expenses.

For domestic qualified adoption expenses paid during or after the tax year in which an adoption becomes final, an employee should claim the tax credit in the tax year in which he or she paid the expenses.

Similar timing rules for claiming the tax credit apply to foreign adoptions, except that such adoptions must have become final before an employee may claim any tax credits. In some situations, this requirement will shift the timing of an employee’s tax credit claim; in other situations, the timing will not change.

The deemed expenses for the adoption of a child with special needs are treated as incurred in the year the adoption becomes final.

The following tables illustrate when to claim the tax credit and when to claim the income exclusion.

When to Claim the Tax Credit
Qualifying expenses paid in…	Domestic Adoption: Take the credit in…	Foreign Adoption: Take the credit in…
any year before the year the adoption becomes final	the year after the year of the payment	the year the adoption becomes final
the year the adoption becomes final	the year the adoption becomes final	the year the adoption becomes final
after the year the adoption becomes final	the year of the payment	the year of the payment

 

When to Claim the Income Exclusion
Qualifying expenses paid in…	Domestic Adoption: Take the credit in…	Foreign Adoption: Take the credit in…
any year before the year the adoption becomes final	the year of the payment	the year the adoption becomes final
the year the adoption becomes final	the year of the payment	the year the adoption becomes final
after the year the adoption becomes final	the year of the payment	the year of the payment

The same dollar caps and income limitations that apply to the adoption assistance exclusion also apply to the tax credit.

Can an employee claim both the income exclusion and the adoption tax credit?

Employees may claim both the income exclusion under Section 137 and the tax credit under Section 23 in regard to the same adoption, but not for the same adoption expenses. This is because the tax credit is not available for expenses paid for or reimbursed by an employer or some other third-party source.

In general, an employee will be better off claiming the tax credit instead of tax-free reimbursements under an adoption assistance plan. The plan should be used for adoptions with actual expenses in excess of $13,190 and for all adoptions of children with special needs. Because the choice between the income exclusion or the tax credit depends on a number of factors (filing status, number of dependents, impact of incurring expenses in multiple years, etc.), it should be made on a case-by-case basis. Three items from the IRS are helpful: Publication 968, Tax Benefits for Adoption, Form 8839, Qualified Adoption Expenses and the instructions to Form 8839. Alternatively, you may wish to consult a tax advisor for guidance.

Do adopted children need Social Security numbers?

Yes. Employees must provide the name, age and Social Security number (SSN) of each eligible adopted child on their Form 1040 income tax return.

How can I obtain a Social Security number for an adopted child?

To apply for an SSN, adoptive parents should file Form SS-5 (Application for a Social Security Card) with the U.S. Social Security Administration. A foster child in the custody of a government agency or court following termination of his or her birth parents’ rights (usually because of abuse or neglect) will usually receive an SSN through the custodian, who then will provide the SSN to the prospective parent. If a prospective parent and the birth parent share information about the adopted child (for example, in open adoptions), the prospective parent should be able to obtain the child’s SSN from the birth parent. A similar situation can occur when a child is adopted by a relative. However, an SSN is not always immediately available for other adoption situations. To address this situation, the adoptive parents should apply to the IRS for a temporary taxpayer identification number (TIN).

What happens if a parent must file taxes before an adopted child is assigned a Social Security number?

Prospective adoptive parents who are otherwise eligible for the Section 137 exclusion or Section 23 tax credit can use a temporary TIN — called an Adoption Taxpayer Identification Number (ATIN) — on their federal income tax returns until they receive SSNs for their soon-to-be adopted children.

ATINs first became available for the 1997 tax year. They expire after two years, but they may be extended under certain circumstances. The IRS is supposed to provide six months’ notice to remind adoptive parents that an ATIN will expire. ATINs are not available for foreign adoptions.

ATINs can satisfy the identification number requirements for claiming the dependency exemption and the child and dependent care credits, but not the earned income tax credit (EITC) under Code Section 32. Parents must obtain and use SSNs for their adopted children when seeking EITCs.

What are the conditions for obtaining an ATIN?

To receive an ATIN for a soon-to-be-adopted child (who does not already have an SSN and who is either a U.S. citizen or a resident alien), an adoptive parent must meet four requirements:

1. the adoptive parent satisfies the eligibility requirements for claiming a personal exemption for the child under Code Section 151;
2. an authorized placement agency has placed the child with the adoptive parent for legal adoption;
3. the SSA cannot assign an SSN to the child — for example, because the adoption is not final; and
4. if the child already has an SSN, the adoptive parent has exhausted all reasonable avenues for obtaining the child’s SSN — for example, because the child’s birth parent will not release it.

How does a parent obtain an ATIN?

To apply for an ATIN, an adoptive parent should complete IRS Form W-7A, “Application for Taxpayer Identification Number for Pending U.S. Adoptions.” The IRS recommends applying at least eight weeks before the due date for individual federal income tax returns (in almost all cases April 15).

Documentary evidence establishing that an authorized placement agency placed the child in the adoptive parent’s home for legal adoption must accompany an ATIN application. Such placement documentation must include the full name of the adoptive parent(s), the child’s full name, the name of the placement agency or agent, the date the child was placed in the adoptive parent’s home and signatures of the parent(s) and an official representative of the placement agency.

What can a parent use as documentary evidence for an ATIN?

Acceptable documentary evidence includes:

• a copy of the placement agreement between the adoptive parent and the authorized agency;
• an affidavit signed by the adoption attorney or government official who placed the child in the home for legal adoption pursuant to a state law;
• a document authorizing the hospital’s release of a newborn to the adoptive parent in a legal adoption; or
• a court document ordering or approving the placement of a child with the prospective parent for legal adoption.

What about children who are resident or nonresident aliens?

An individual taxpayer identification number (ITIN) should be obtained if the child is a resident or nonresident alien and ineligible for an SSN. An ATIN should be used for a resident alien child who would otherwise be eligible for an SSN, but for whom an SSN cannot be obtained in time for the employee to file the federal income tax return. To apply for an ITIN, adoptive parents should file IRS Form W-7, “Application for IRS Individual Taxpayer Identification Number.”

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26 U.S.C. § 137 : US Code – Section 137 Adoption assistance plans

(a) Exclusion

(1) In general
Gross income of an employee does not include amounts paid or expenses incurred by the employer for qualified adoption expenses in connection with the adoption of a child by an employee if such amounts are furnished pursuant to an adoption assistance program.

(2) $13,190 exclusion for adoption of child with special needs regardless of expenses
In the case of an adoption of a child with special needs which becomes final during a taxable year, the qualified adoption expenses with respect to such adoption for such year shall be increased by an amount equal to the excess (if any) of $13,190 over the actual aggregate qualified adoption expenses with respect to such adoption during such taxable year and all prior taxable years.

(b) Limitations

(1) Dollar limitation
The aggregate of the amounts paid or expenses incurred which may be taken into account under subsection (a) for all taxable years with respect to the adoption of a child by the taxpayer shall not exceed $13,190. (2014)

(2) Income limitation
The amount excludable from gross income under subsection (a) for any taxable year shall be reduced (but not below zero) by an amount which bears the same ratio to the amount so excludable (determined without regard to this paragraph but with regard to paragraph (1)) as

(A) the amount (if any) by which the taxpayers adjusted gross income exceeds $150,000, bears to

(B) $40,000.

(3) Determination of adjusted gross income
For purposes of paragraph (2), adjusted gross income shall be determined

(A) without regard to this section and sections 199, 221, 222, 911, 931, and 933, and

(B) after the application of sections 86, 135, 219, and 469.

(c) Adoption assistance program
For purposes of this section, an adoption assistance program is a separate written plan of an employer for the exclusive benefit of such employers employees

(1) under which the employer provides such employees with adoption assistance, and

(2) which meets requirements similar to the requirements of paragraphs (2), (3), (5), and (6) of section 127 (b).

(d) Qualified adoption expenses
For purposes of this section, the term qualified adoption expenses has the meaning given such term by section 23 (d) (determined without regard to reimbursements under this section).

(e) Certain rules to apply
Rules similar to the rules of subsections (e), (f), and (g) of section 23 shall apply for purposes of this section.

(f) Adjustments for inflation
In the case of a taxable year beginning after December 31, 2002, each of the dollar amounts in subsection (a)(2) and paragraphs (1) and (2)(A) of subsection (b) shall be increased by an amount equal to

(1) such dollar amount, multiplied by

(2) the cost-of-living adjustment determined under section 1 (f)(3) for the calendar year in which the taxable year begins, determined by substituting calendar year 2001 for calendar year 1992 in subparagraph (B) thereof.

If any amount as increased under the preceding sentence is not a multiple of $10, such amount shall be rounded to the nearest multiple of $10.