Under the recently enacted Patient Protection and Affordable Care Act and its companion bill, the Health Care and Education Reconciliation Act of 2010 (collectively the "Act"), group health plans that offer coverage for dependent children must make coverage available to adult children until they reach age 26. There is no requirement for a plan to provide coverage for dependents, but plans that provide coverage for dependent children must extend coverage to children until they turn age 26. This new rule is generally effective for plan years beginning on or after September 23, 2010 (i.e., January 1, 2011 for calendar year plans).
Exclusion for Tax Purposes of Employer-Provided Reimbursements
The Act amended Code Section 105(b), effective March 30, 2010, to extend the exclusion from income for reimbursements for medical care under employer-provided accident or health plans to include any employee's child who has not attained age 27 as of the end of the tax year. The Code Section 152(c) age limit, residency, support, and other tests do not apply to such a child for Code Section 105(b) purposes. For purposes of this rule, “child” means an employee’s son, daughter, stepson, or stepdaughter and an individual who is legally adopted by the employee, an individual who is lawfully placed with the employee for legal adoption by the employee, and an eligible foster child.
The extended exclusion applies to employer-provided reimbursements, cafeteria plans, flexible spending arrangements (FSAs), health reimbursement arrangements (HRAs), voluntary employees' beneficiary associations (VEBAs), and the Code Section 162(l) above-the-line deduction for a self-employed individual's medical care insurance costs.
On April 27, 2010, the IRS issued Notice 2010-38, which provides guidance on the tax treatment of health coverage for children under age 27 under the Act. Taxpayers may rely on Notice 2010-38 pending the issuance of amended regulations.
1. Extension of Exclusion to Coverage under Medical Plans.
Under the pre-Act law, the Code Section 106 exclusion from income for employer-provided accident or health plan coverage paralleled the Code Section 105(b) exclusion for reimbursements. The IRS will amend the Code Section 106 regulations retroactively to March 30, 2010, to provide that coverage for an employee's child who has not attained age 27 by the end of the tax year is excluded from gross income.
2. Cafeteria Plans, Flexible Spending Arrangements, and Health Reimbursement Arrangements.
The cafeteria plan rules under Code Section 125 permit employees to elect between cash and certain qualified benefits, including accident or health plans and health flexible spending arrangements (i.e., health FSAs). The exclusion for the reimbursement and coverage of an employee's child who has not attained age 27 carries forward automatically to the definition of qualified benefits for cafeteria plans, including health FSAs. Children who have not attained age 27 by the end of the tax year will be treated the same as other dependents for cafeteria plans.
Cafeteria plans may permit employees to revoke elections during a period of coverage and to make new elections only in limited circumstances, such as a change in status event, e.g., changes in the number of an employee's dependents. The regulations do not currently permit election changes for children under age 27 who are not the employee's dependents as defined in Code Section 152(e). The Notice provides that the IRS and Treasury will amend the regulations, effective March 30, 2010, to include change in status events affecting nondependent children under age 27, including a child becoming newly eligible for coverage or eligible for coverage beyond the date on which the child otherwise would have lost coverage.
Cafeteria plans may need to be amended to include employees' children who have not attained age 27 as of the end of the tax year. Generally, amendments to cafeteria plans may be effective only prospectively. However, as of March 30, 2010, employers with cafeteria plans may permit employees to immediately make pre-tax salary reduction contributions to provide accident or health benefits for children under age 27, even if the plan has not yet been amended to cover these individuals. A retroactive amendment to a cafeteria plan to cover children under age 27 must be made no later than December 31, 2010, and must be effective retroactively to the first date in 2010 when employees are permitted to make pre-tax salary reduction contributions to cover children under age 27 (but not before March 30, 2010).
3. FICA, FUTA, and Income Tax Withholding Treatment.
Coverage and reimbursements under an employer-provided accident and health plan for employees and their dependents that are provided for an employee's child under age 27 are generally excluded from wages for FICA (Federal Insurance Contributions Act), FUTA (Federal Unemployment Tax Act), or RRTA (Railroad Retirement Act) purposes. Such coverage and reimbursements also are exempt from income tax withholding.
4. VEBAs, Pension Plans, and Self-Employed Individuals
The Notice also addresses the impact of the Act on three other laws dealing with medical benefits for dependents: (i) VEBAs, which are tax-exempt entities, may provide for the payment of life, sickness, accident, and other benefits to employee members, their dependents, and designated beneficiaries; (ii) pension plans may establish and maintain separate accounts to provide for the payment of benefits for sickness, accident, hospitalization, and medical expenses of retired employees, their spouses, and their dependents; and (iii) self-employed individuals generally may deduct amounts paid during a taxable year for insurance that constitutes medical care for the individual and his or her spouse and dependents, if certain requirements are satisfied. The Act amends all three rules to provide that the term “dependent” includes any individual’s child who has not attained age 27 as of the end of the tax year.
Kelley Drye & Warren LLP
Kelley Drye & Warren's Employee Benefits and Executive Compensation Practice Group advises clients on a broad range of employee benefits and executive compensation issues, including qualified and nonqualified retirement plans, equity-based compensation arrangements, health and welfare programs, fiduciary issues involving the investment of plan assets, mergers and acquisitions, cross-border employee benefits and compensation arrangements, and related legal and tax issues. We will continue to provide updates on the new health care law as guidance is issued. For more information about this Client Advisory, please contact: