January 27, 2011
Differences in Federal and State Tax Rules for Dependent Child Coverage Raise Issues for Group Health Plans
The Affordable Care Act (the Act)1 requires group health plans to continue coverage for certain children up to age 26.2 This Capital Checkup discusses the administrative complexities that may arise when the federal approach to taxation of that dependent coverage differs from state law.
New Federal Rules
The Act simplified the federal tax rules that determine when group health plans may provide tax-free health coverage to a participant's children.3 The new rules, which took effect March 30, 2010, allow plans to provide federally tax-free health coverage to a participant's "child" through the end of the calendar year in which the child turns age 26.4 This is much simpler than the old federal rules, which required a more detailed analysis of whether a child met the applicable requirements set out in another subsection of the Internal Revenue Code (IRC), specifically, the requirements applicable to a "qualifying child" and a "qualifying relative."5
Group health coverage that is provided to individuals who are not eligible for tax-free coverage under federal law results in the fair-market value of coverage being taxable to the participants. This is commonly known as "imputing income" to the participant.
State Laws Have Not Kept Pace with Federal Changes
State laws governing taxation of group health plan coverage provided to children generally follow the federal rules. However, in many states (e.g., Arizona, California and New Jersey), state tax laws take a different approach, most often because these state laws are tied to an older version of the IRC pre-dating the March 2010 changes made by the Act. As a result, unless these state laws on taxation of benefits provided to children are updated to parallel the new federal approach, coverage provided to certain older children can continue to be provided tax free under federal law, but may result in imputed income to the participant under state tax law. The relevant state law for this purpose would be the state where the participant files personal income tax returns.
Implications for Plan Sponsors
Plan sponsors should continue to assure that their dependent coverage policies are up-to-date and in compliance with the Act. To the extent that plans cover dependents who are not able to receive tax-free coverage under state law, plan sponsors should consult with their tax advisors to determine whether income needs to be imputed and the required process and forms for doing so.
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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. Sibson Consulting can be retained to work with plan sponsors and their attorneys on compliance issues, including methods for calculating fair market value of health coverage.
- The Affordable Care Act is the abbreviated name for 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. (Return to the Capital Checkup.)
- For information about this requirement and related guidance, see Sibson Consulting's November 2010 Health Care Reform Insights, "Agencies Continue to Clarify Rules on Coverage for Children". (Return to the Capital Checkup.)
- 3 For more information about this change, see Sibson's May 3, 2010 Capital Checkup, "Treasury Guidance on Health Care Reform's New Tax Treatment of Coverage for Adult Children". (Return to the Capital Checkup.)
- Internal revenue Code (IRC) §152(f)(1) defines "child" to include: son/daughter, adopted child (or one placed for adoption with taxpayer), stepchild, and eligible foster child. (Return to the Capital Checkup.)
- See IRC §152(c) and (d), respectively. The old rules still apply when coverage is provided to children who do not fit within the definition of "child" found in IRC §152(f)(1). (Return to the Capital Checkup.)
Capital Checkup is Sibson Consulting's periodic electronic newsletter summarizing activity in Washington 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.