Health Reform - IRS Provides Guidance on the Tax Treatment of Employment-Provided Health Benefits for Children Under Age 27

As mentioned previously (please see our Client Advisory from May 10, 2010), the Patient Protection and Affordable Care Act and the Health Care and Education Reconciliation Act of 2010, known together as the health care reform laws, require certain group health plans to cover adult children of employees until age 26.  The health care reform laws also amend the Internal Revenue Code (the "Code") to exclude from an employee's income employer-provided dependent coverage for adult children who have not attained age 27 as of the end of the year.  This Client Advisory addresses recent guidance issued by the IRS and the interim final regulations issued by the Treasury Department, Department of Labor and Department of Health and Human Services regarding these new requirements.

Extended Coverage of Children.  Under the new laws, group health plans that offer dependent coverage of children must make the same coverage available to any employee's child who is under age 26.  Only grandfathered plans can use a dependent child's eligibility for other employer-provided group health plan coverage as an eligibility exclusion.  However, this special rule for grandfathered plans applies only when the other plan for which the child is eligible is not the plan of a parent, and only for plan years beginning before January 1, 2014.

The regulations clarify that group health plans cannot limit coverage of children based on student status, residency, financial support, or marriage.  However, the new laws do not require a group health plan to cover the spouse of an eligible child or a child of a child receiving dependent coverage. 

In the case of a child whose coverage ended, or who was denied or was not eligible for coverage under a group health plan under prior law, the plan must give the child at least 30 days to enroll or reenroll in the plan.  The notice of the new enrollment right must be in writing and can be sent to the employee on behalf of the child.  If the child is enrolled, coverage must begin not later than the first day of the first plan year beginning on or after September 23, 2010, even if the child's election window expires after the beginning of the plan year. 

The child must be offered all of the benefit packages available to similarly situated individuals who did not lose coverage by reason of cessation of dependent status.  In addition, if a child is eligible to enroll under the new laws, but the employee is eligible and has not enrolled, the plan must give both the parent and the child the opportunity to enroll.  Similarly, if a plan has more than one benefit package option, the plan must provide an opportunity for the child to enroll in any benefit package option for which the child otherwise is eligible (and must allow the parent to switch benefit package options to match the child's election). 

A child who qualifies for enrollment under the new law and is covered under COBRA must be given the opportunity to enroll as a dependent of an active employee.  If the child subsequently loses eligibility for coverage due to a qualifying event, the child will have another opportunity to elect COBRA continuation coverage at that time. 

Taxation of Coverage and Benefits Under the Extended Coverage Rule.  In recognition of the extended coverage required under the health care reform laws, the Code has been amended to exclude this coverage from an employee's gross income.  However, while the extended coverage rule discussed above applies to adult children under the age of 26 and is effective for the first plan year beginning on or after September 23, 2010, the rules regarding the taxation of this coverage apply to children who have not reached age 27 by the end of the taxable year. These rules are effective now.

In IRS Notice 2010-38, the IRS addressed the changes made by the health care reform laws to extend coverage to adult children and exclude it from the employee's gross income. The IRS offered several confirmations and clarifications, including the following:

• Exclusion for Reimbursements. The exclusion of reimbursements for medical care from an employee's gross income under Code § 105(b) now applies to adult children under age 27 as of the end of the employee's taxable year (assumed to be the calendar year), even if the child does not qualify as the employee's tax dependent. For purposes of this tax treatment, a "child" includes an employee's biological child, stepchild, legally adopted child, child placed with the employee for adoption and an eligible foster child. The employer may rely on the employee's representation as to the child's date of birth.

• Exclusion for Coverage. The IRS stated that it will amend the regulations under Code § 106 retroactively to March 30, 2010, to provide that accident or health coverage for adult children under age 27, as of the end of the taxable year, is excluded from gross income.

• Health FSAs, HRAs, and Cafeteria Plans. The new tax treatment applies to coverage and reimbursement from health flexible savings accounts (FSAs) and health reimbursement accounts (HRAs) for children who are under age 27 as of the end of the employee's taxable year. Employers may permit employees to begin making pre-tax salary reduction contributions immediately for the coverage of adult children as of March 30, 2010, even if they do not amend their cafeteria plans to include them until a later date, so long as a retroactive amendment is made by December 31, 2010. The IRS also intends to amend its permitted election change regulations retroactively to March 30, 2010, to include change-in-status events affecting nondependent children under age 27.
  
  
  • NOTE: Health savings accounts (HSAs) are not mentioned in the guidance and the health care reform laws did not amend Code § 223, which governs HSAs.  As such, the tax treatment presumably does not apply to HSAs. 

• Employment Taxes. The guidance clarifies that coverage and reimbursements for adult children under 27 are not considered wages for FICA and FUTA purposes.

While this guidance is helpful in resolving some issues relating to the extended coverage of children and the new tax treatment for adult children under age 27, questions remain.  We will update you when additional guidance is provided.  In the meantime, employers may consider taking the following actions to comply with upcoming requirements and to take advantage of the new tax treatments:

• If early implementation of the extended coverage is desired, employers should amend their group health plans to recognize the new enrollment right and make sure that employees are notified of the new rules.

• Employers will want to talk to their administrators to ensure that open enrollment for the plan year beginning on and after September 23, 2010, meets the enrollment window and notice requirements imposed by the new law.

• Employers should amend their cafeteria plans by December 31, 2010, in order to allow employees to 1) make pre-tax salary reduction contributions for the coverage of their adult children and 2) allow employees to change their election to add or continue coverage for adult children.

• Employers who sponsor FSAs and HRAs should consider amending their plans to allow reimbursements for medical expenses incurred for adult children.

Our Employee Benefits Team is available to answer any questions you may have on health care reform or any other employee benefit matter.

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If you have any questions about this Client Advisory, please contact any member of our Employee Benefits Team.

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