Yes. An adoption assistance benefit is specifically authorized as a permitted benefit under the Internal Revenue Code. Thus, a cafeteria plan (a Section 125 plan) may be established that permits an employee to make salary reduction contributions under the plan to an adoption assistance flexible spending account (FSA) to obtain reimbursements for qualified expenses. Salary reductions for an adoption assistance benefit under Code Sec. 125 are exempt from all federal income and employment taxes. However, the actual reimbursements from the Section 125 plan for the employee's qualified expenses are subject to FICA and FUTA taxes (but not federal income tax even if greater than the applicable dollar limit for the current year).

A cafeteria plan providing for adoption assistance benefits also can permit mid-plan-year changes in the employee's benefit elections upon the commencement or termination of an adoption proceeding.

Use it or lose it rules apply. Note that the "use it or lose it" rules that are imposed under the cafeteria regulations also apply to adoption assistance benefits. These at-risk rules require that any unreimbursed salary deductions be forfeited at the end of the plan year. That is, unused amounts may not be carried forward to a subsequent year. For this reason, adoption assistance FSA participation must be carefully planned. If an expected adoption is not completed during a given plan year, in some circumstances, the participant will forfeit dollars contributed to the FSA. Similarly, although termination of adoption proceedings is a qualified reason to cease contributions to an adoption assistance FSA, funds that have already been contributed may not be returned to the plan participant, except via qualified claims of adoption expense.

Source: Aspen Payroll Answer Book.