Age 26 or Age 27, Two Different Rules

In Brief

The Health Care Reform laws mandate that an employer must make coverage available to dependents until age 26. Please refer to our earlier memorandum for details. The new law also removes the imputed income tax liability for employees whose children receive health care coverage beyond their 24th birthday and before age 27. The IRS Notice 2010-38, along with a White House press release has led to some confusion. The purpose of this memorandum is to address the IRS Notice.

The New Tax Law

The law removes the imputed income tax requirements, relieving employers from having to impute income for employer-provided health coverage to children over-age 19 who do not meet the definition of qualifying child, which requires that they be full time students and living with the taxpayer (IRC Section 152(f)(1)). The relief applies to coverage provided or continuing to be provided after March 30, 2010. Employers must treat coverage provided prior to March 30, 2010 as subject to imputed income. Please note that whether before or after March 31, 210, the cost of coverage is not subject to FICA or FUTA taxes. Technically speaking, this new law applies to IRC Sections 105 (tax free benefits), 106 (non-taxable employer contributions), and 125 (cafeteria plans). By not amending IRC Section 152 (definition of dependents), Congress makes it clear that this imputed income exclusion only applies to group health plan coverage.

Cafeteria Plan Rules

The new law modifies cafeteria plan rules to permit pre-tax contributions for coverage applicable to over-age dependents and to permit tax free benefits for over-age dependents under a health care spending account. Cafeteria plan regulations currently do not permit the addition of an over-age dependent as an opportunity to change an FSA election amount. This IRS Notice says that the IRS and Treasury intend to amend regulations (1.125-4) effective retroactively to March 30, 2010 to treat the addition of coverage for an over-age dependent up to age 27 as a qualifying status change. The employer can choose to permit the change in election but is not required to do so.

The Meaning of “Up to Age 27”

For purposes of this new law, the coverage provided is tax free through December 31 (end of the taxpayer’s tax year), for the year in which the participating dependent turns 27.

State Law Mandates

Certain states require insured plans to provide health coverage to over-age dependents beyond age 27, the limit permitted under federal law. Federal income tax rules will require the inclusion of imputed income for coverage provided beyond age 27. States with these laws have their own separate tax rules.

Action Plan

1. If an employer wants to permit a new election under the cafeteria plan with the addition of an over-age dependent, he must amend the cafeteria plan by the end of the current plan year. Although it is permitted here, the amendment appears to contradict the IRS proposed rule prohibiting retroactive cafeteria plan amendments.

2. Employers must impute income for health care coverage provided to non-qualifying dependents any time prior to March 30, 2010. The imputed income amount will appear on W-2s issued for 2010 and prior years.

3. Employers should not collect FICA or FUTA taxes.