If a Dependent Child’s Coverage Doesn’t Meet Tax Code Requirements, Does Imputed Income Result?

May 4, 2010 (PLANSPONSOR.com) - Plan sponsors have lots of issues to deal with  - but perhaps none looms quite so large these days as getting a handle on what they need to do to prepare for the impact of the Patient Protection and Affordable Care Act (PPACA).


This week’s question:

Under the new health reform law, a group health plan that provides dependent coverage must allow an adult child to continue coverage until the child turns 26(1).  If an employee’s child who is covered under this requirement does not meet the tax code dependent requirements, is the value of the coverage treated as imputed income?

Under PPACA, a group health plan or health insurance issuer offering group or individual health insurance coverage that provides dependent coverage must allow an adult child to continue coverage until the child turns 26 (1), regardless of student or marital status.  This requirement is effective in 2011 for calendar year plans.  For plan years beginning before January 1, 2014, grandfathered group health plans are not required to extend adult dependent coverage if the child is eligible to enroll in another eligible employer-sponsored health plan.  PPACA also allows the Department of Health and Human Services (HHS) to issue regulations regarding the scope of “dependents” that are eligible under this requirement. 

The Health Care and Education Reconciliation Act of 2010 (Reconciliation Bill), which was subsequently enacted on March 30, 2010, made certain amendments to PPACA.  Among other things, the Reconciliation Bill amended the Internal Revenue Code (Code) to provide that reimbursements from an employer-provided health plan for medical expenses of an adult child who has not attained age 27 as of the end of the calendar year are excluded from income.  The provision, which is effective as of March 30, 2010, did not, however, amend the Code to provide that employer-provided health coverage to such an adult child is excludable from income.

The IRS recently issued Notice 2010-38, which provides that the exclusion from gross income for employer-provided coverage applies to an employee’s child who has not attained age 27 as of the end of the year, regardless of whether the child is the employee’s dependent within the meaning of Code section 152(a).  This means that the age limit, residency, support, and other tests in Code section 152(c) do not apply to such a child.  Notably, the Notice also states that the IRS intends to amend its regulations to provide that employer-provided coverage for an employee’s eligible adult child will be excluded from income beginning March 30, 2010.  It also clarifies that the reimbursement and coverage exclusions for adult children apply for purposes of the cafeteria plan rules, including health flexible spending arrangements (FSAs), and with respect to health reimbursement arrangements (HRAs).

Notice 2010-38 also announces that the IRS will amend its regulations under the cafeteria plan rules, effective retroactively to March 30, 2010, to permit mid-year changes in coverage elections with respect to adult children under age 27 who become newly eligible for coverage or eligible for coverage beyond the date such a child otherwise would have lost coverage.  This means that employers may immediately permit employees to make pre-tax, salary reduction elections under a cafeteria plan for eligible adult children, including contributions to a health FSA.  Further, the Notice helpfully provides that any cafeteria plan amendment needed to include adult children under age 27 may be made retroactively so long as the amendment is made by December 31, 2010, and is effective retroactively to the first date in 2010 (no earlier than March 30) that employees are permitted to make an election to cover an eligible adult child.

Please note that PPACA and the Reconciliation Bill did not specify whether a distribution from a health savings account (HSA) to reimburse an adult child’s medical expenses is excludable from income, and Notice 2010-38 does not address this issue.  Thus, it appears that without a future “technical correction,” HSA distributions for medical expenses of an adult child would not be excludable from income, unless the child is a dependent under Code section 152 (e.g., as a “qualifying relative”).

 (1) There are two separate provisions/age rules.  Under the adult child coverage mandate, which is referenced in this question, the requirement applies until the child turns age 26.  Under the new tax exclusion rule, the favorable tax treatment applies to children who have not attained age 27 as of the end of the year.  Guidance is expected shortly on the up to age 26 mandate.


You can find a handy list of Key Provisions of the Patient Protection and Affordable Care Act and their effective dates at http://www.groom.com/HCR-Chart.html  



Christy Tinnes is a Principal in the Health & Welfare Group of Groom Law Group in Washington, DC.  She is involved in all aspects of health and welfare plans, including ERISA, HIPAA portability, HIPAA privacy, COBRA, and Medicare.  She represents employers designing health plans as well as insurers designing new products.  Most recently, she has been extensively involved in the insurance market reform and employer mandate provisions of the health care reform legislation.

Brigen Winters is a Principal at Groom Law Group, Chartered, where he co-chairs the firm’s Policy and Legislation group. He counsels plan sponsors, insurers and other financial institutions regarding health and welfare, executive compensation, and tax-qualified arrangements, and advises clients on legislative and regulatory matters, with a particular focus on the recently-enacted health reform legislation.

PLEASE NOTE:  This feature is to provide general information only, does not constitute legal advice, and cannot be used or substituted for legal or tax advice.


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