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WASHINGTON-Employers that want to take advantage of a change in federal law that allows them to provide tax-favored adoption assistance benefits programs for their employees now have guidance from the Internal Revenue Service on how to operate those programs.
Under a provision in tax legislation passed last year and effective Jan. 1, employers can reimburse employees for up to $5,000 of expenses per adoption without that reimbursement being added to employees' taxable income. In the case of an adoption of a child with special needs, the tax-free limit on employer reimbursement is $6,000. Individuals who adopt children also are eligible for tax credits.
Even without the new tax breaks, a good number of large employers already have programs that reimburse employees for a portion of adoption-related expenses. A new Hewitt Associates L.L.C. study of more than 1,000 major employers found that 23% offer an adoption reimbursement program.
Typically, corporate programs reimburse employees for between $2,000 and $2,500 of adoption expenses, said Karol Rose, a principal with Kwasha Lipton L.L.C. in Fort Lee, N.J. The cost of an adoption ranges between $10,000 and $30,000.
With the new tax breaks extended by Congress, more employers are expected to add adoption assistance benefit programs,say consultants. "These are relatively low-cost programs that are very much appreciated by employees," Ms. Rose said.
And for employers that have programs in place or are considering setting up adoption assistance programs, the IRS has provided answers in Notice 97-9 to questions that have cropped up since Congress passed legislation last year giving adoption assistance benefits tax-favored status.
Some of the questions that have popped up and the answers provided by the IRS include:
How long will the new tax breaks for adoption expenses remain in effect?
In the case of a regular adoption, the tax break expires after Dec. 31, 2001. However, the tax-favored status of employer reimbursement for adoption expenses for children with special needs has no expiration date.
What are considered qualified adoption-related expenses?
Qualified adoption expenses include reasonable and necessary adoption fees, court costs, attorneys' fees, traveling expenses and other expenses directly related to the legal adoption of a child.
What is an eligible child and a child with special needs?
An eligible child is any individual who is under 18 at the time an adoption expense is paid or incurred or is physically or mentally incapable of caring for himself or herself.
A child with special needs must meet two additional requirements. A state must have determined that the child cannot or should not be returned to the parents' home and the child cannot be placed with adoptive parents without adoption assistance because of a specific factor or condition.
Examples provided by the IRS of a special factor or condition include the child's ethnic background, membership in a minority group, medical condition or disability.
In addition, a child with special needs must be a citizen or resident of the United States.
What special requirements apply to employer adoption assistance programs?
Employers are required to provide employees with a written description of the plan.
In that description, the employer must explain to employees the terms and availability of the program.
In addition, an adoption assistance program must benefit employees generally and eligibility requirements may not discriminate in favor of highly compensated employees.
Can employers reimburse all employees-regardless of employee income-for adoption-related expenses on a tax-free basis?
No. Tax-free reimbursement can be provided to all employees with adjusted gross incomes of $75,000 or less. For those with incomes of between $75,000 and $115,000, the tax breaks decrease as income rises. The IRS has set up a special formula to calculate how much in employer-provided adoption assistance benefits is to be included as taxable income for employees with adjusted gross incomes of between $75,000 and $115,000. The tax breaks are not available for employees with adjusted gross incomes at or above $115,000.
Are the $5,000 and $6,000 caps on tax-free employer reimbursement per child or annual limits?
The caps are per-child limits. Take the situation of an employer that reimbursed an employee for $2,000 in adoption-related expenses incurred in 1997, when the adoption effort commenced, and $3,000 of expenses incurred in 1998, when the adoption was completed.
In that situation, the $2,000 of employer-provided reimbursement in 1997 would be excluded from the employee's taxable income that year, while the $3,000 provided in 1998 would be excluded from the employee's 1998 taxable income.
However, if the facts were slightly changed and the employee received $5,000 in employer reimbursement in 1997 and $2,000 in 1998 the $2,000 in employer reimbursement would be included in the employee's 1998 taxable income.
The new law also allows individuals to take up to a $5,000 tax credit-or up to a $6,000 tax credit for a child with special needs-for adoption-related expenses. Can an employee claim both a credit and an exclusion of employer-provided reimbursement paid in connection with the adoption of a child?
Yes, but only if the credit and reimbursement are for different expenses. For example, assume an employee paid an adoption agency $5,000 in connection with the adoption of a child. In addition, the employee's company reimbursed the employee for $5,000 of legal expenses the employee paid to an attorney and which were reimbursed by his company.
In that situation, the employee could claim a $5,000 tax credit, while the $5,000 in employer-provided reimbursement could be excluded from the employee's taxable income because the credit and exclusion were not for the same expenses.