May 3, 2010
Treasury Guidance on Health Care Reform’s New Tax Treatment of Coverage for Adult Children
The Internal Revenue Service (IRS) announced on April 27, 2010, the release of a new Treasury Notice (Notice 2010-38) on the health care reform law's tax treatment of employer-provided coverage for adult children.1 The notice confirms that group health plans may cover certain adult children on a tax-free basis, retroactive to March 30, 2010. It also permits employers to allow employees to change their elections under the employer's Section 125 cafeteria plan, retroactive to March 30, 2010, provided the employer amends the cafeteria plan document by the end of 2010.
The new tax provision in the health care reform law greatly simplifies the tax requirements that apply in determining whether a plan may provide tax-free health coverage to an employee's child.2 It adds a new category of children who may receive tax-free coverage: a child, defined by reference to §152(f) of the Internal Revenue Code (IRC), who has not reached age 27 by the end of the taxable year. For this purpose, a child includes a son, daughter, stepchild, adopted child (or child lawfully placed for adoption) or an eligible foster child (defined as an individual placed with the employee by an authorized placement agency or by judgment, decree or other court order).
While Notice 2010-38 answers questions about taxation of coverage for adult children, it does not address the separate requirement under PPACA to continue coverage for adult children until they reach age 26.3
Treasury Notice 2010-38
The Notice answers some key questions about the new tax provision, including the following:
- With respect to health coverage for an employee's child, employers may ignore the complex tax rules for "dependents" under IRC §152. If a child is the employee's child and meets the age requirement (i.e., will not reach the age of 27 by the end of the tax year), then coverage may be provided on a tax-free basis. For the tax-free rule to apply, the child does not have to live at home, be a student, be financially dependent on the parent, be unmarried, or meet any of the other requirements historically associated with tax dependency.
- Employers may permit employees to change their elections under the employer's Section 125 plan (including both adding children and changing the amount of the employee's contribution to a FSA) retroactively to March 30, 2010. Although a change in elections would not be permitted under existing change-in-status rules (which apply only to changes in the number of tax-qualified dependents), the IRS will amend those rules retroactively in order to explicitly permit this change.
- The new rule applies to reimbursements under Health Flexible Spending Arrangements (FSAs) and Health Reimbursement Arrangements (HRAs).4 It also applies to sickness and accident coverage provided through a voluntary employees' beneficiary association (VEBA).
- Under the new tax provision, the child cannot turn 27 at any time during the tax year. Employers may assume that the tax year at issue is the calendar year (as it is based on the employee's tax year, not the plan year). Employers may rely on the employee's representation as to the child's birth date. This effectively means that coverage may be provided on a tax-free basis through the end of the calendar year in which the child turns 26.
- Employers can provide tax-free coverage to a child who is married. If the employer also extends coverage to the child's spouse, the fair market value of the spouse's coverage would have to be imputed as income to the employee, assuming the child's spouse does not meet the tax dependency requirements under IRC §152(d) with respect to the employee.
- Employers can provide tax-free coverage to an adult child even if the child is eligible for or has other coverage as an employee through another plan. (This rule is different from the PPACA's requirement to extend dependent coverage up to age 26, because in that case, a plan sponsor does not have to provide coverage to a child who has access to other employer-sponsored coverage.)
Implications for Plan Sponsors
The Treasury notice provides important information for plan sponsors that are deciding how and when to comply with the law's extended coverage requirement (coverage up to age 26). The tax provision gives employers the option to extend tax-free coverage sooner than the mandate requires (even retroactive to March 30, 2010) and to extend it beyond the child's 26th birthday through the end of the calendar year in which the child turns age 26. Employers may wait until their next plan year to implement the coverage extension, but they may choose to do so sooner. Employers that extend coverage earlier than required and that choose to permit employees to change their cafeteria plan elections mid year must keep in mind the need to amend their cafeteria plan document by the end of 2010 to permit this election.
Notice 2010-28 also provides important information for plan sponsors that are now imputing income to employees for coverage provided to older children in response to the many state insurance laws mandating extended coverage. Plan sponsors that are now imputing income may stop doing so for that group of children covered by the new tax provision.
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As with all issues involving the interpretation or application of laws and regulations, plan sponsors should rely on their attorneys for authoritative advice on the interpretation and application of the sweeping national health care reform law and related guidance. The Segal Company can be retained to work with plan sponsors and their attorneys on compliance issues.
- Notice 2010-38 is available at: http://www.irs.gov/pub/irs-drop/n-10-38.pdf. (Click on the following text to return to the Capital Checkup.)
- The health care reform law is the Patient Protection and Affordable Care Act (PPACA), Public Law No. 111-148, as modified by the subsequently enacted Health Care and Education Reconciliation Act (HCERA), Public Law No. 111-152. The new tax provision is in HCERA Section 1004(d). (Click on the following text to return to the Capital Checkup.)
- For information about the requirement to continue coverage for adult children until age 26, see The Segal Company's April 2010 Health Care Reform Insights, "Extension of Dependent Coverage to Age 26". (Click on the following text to return to the Capital Checkup.)
- Neither the law nor the notice address Health Savings Accounts (HSAs). (Click on the following text to return to the Capital Checkup.)
Capital Checkup is The Segal Company's periodic electronic newsletter summarizing activity with respect to health care and related subjects. Capital Checkup is for informational purposes only. It is not intended to provide guidance on current laws or pending legislation. On all issues involving the interpretation or application of laws and regulations, plan sponsors should rely on their attorneys for legal advice.