Employee Benefits Compliance

California Conforms to Federal Tax Law: No State Tax on Employer-Paid Benefits for Adult Dependents

The California State Legislature has approved A.B. 36, so employees will not be subject to California state income tax on amounts their employers pay toward coverage for adult children through age 26. This conforms California state tax law to the federal Internal Revenue Code, which was amended by the Health Care Reform law and regulations to eliminate federal taxation of employer-paid coverage for employees’ adult children through age 26. California Governor Jerry Brown is expected to sign A.B. 36 soon.

Under existing California tax law, an employee is subject to state income taxes on the value of employer-paid coverage for the employee’s child(ren) unless a five-part test is met. One of the requirements of the test is that the employee’s child must be under age 19, or 24 if the child is a full-time student. Since March 30, 2010, employees have not been subject to federal taxation of employer-paid coverage for children through the end of the year in which the child attains age 27, so this has created an administrative/payroll burden for employers. This new California law makes federal and California tax treatment the same for group health plan purposes. The new law does not change California’s definition of “dependent” however; for purposes other than group health plans, dependent status from ages 19-24 also requires full-time student status.

Other States

A number of other states also have recently enacted measures that conform their state tax law to federal tax law. Minnesota Gov. Mark Dayton signed conformity legislation on March 21 (H.F. 79), and Kentucky Gov. Steven Beshear signed conformity legislation last week (H.B. 255). Several other states have conformity bills making their way to the Governors for approval: the Vermont House approved H. 436, and the South Carolina Senate passed S. 522. States that already enacted conformity legislation earlier this year include Maine, Oregon and Virginia. Many states automatically conform to federal tax law, so conformity legislation is not needed.

Next Steps for Employers

You could wait until the Gov. signs the bill before you change your current procedures, if change is needed.

Assuming the Gov. signs A.B. 36, this means that state income and employment taxes are not owed on amounts the employer contributes toward coverage for employees’ adult children who do not otherwise meet the state tax code definition of “dependent.”

  • Any state tax amounts you have already withheld in 2011 should be credited back to employees in future paychecks, as an offset against state taxes that would otherwise be withheld in future checks.

  • If you have already sent these state tax amounts to the California Franchise Tax Board and/or the Employment Development Dept. (EDD), you should make appropriate adjustments in future reporting. The two departments no doubt will issue guidance on how to make adjustments in future tax submissions.

  • If you imputed income in 2010 equal to the employer contribution toward coverage for adult dependents and withheld state tax amounts on the imputed income, you may need to issue amended 2010 Forms W-2 to affected employees. Seek the advice of your tax advisor on how to return the overwithheld amounts.