IRS Guidance on Employer Health Care for Children under Age 27

Friday, April 30, 2010

On April 27, 2010, in a 12 page notice, the IRS released employer guidance (IRS Notice 2010-38) on taxation of employer-provided health care for employee’s children under age 27 as provided for under The Patient Protection and Affordable Care Act and the Health Care and Education Reconciliation Act, (Public Law No. 111-149). Furthermore, in addition to changing the various tax rules, The Patient Protection and Affordable Care Act and the Health Care and Education Reconciliation Act mandates health care plans that provide dependent coverage of children to continue to make the coverage available for an adult child until the child turns age 26. The extended coverage must be provided no later than plan years beginning on or after Sept. 23, 2010. The favorable tax treatment described in IRS Notice 2010-38 applies to that extended coverage.

Effective March 30, 2010 employers with IRS § 125 cafeteria plans may now generally cover children under age 27 using pre-tax contributions to pay for this benefit. Nevertheless, employers with IRS § 125 cafeteria plans will need to amend those plans within the required time periods as permitted under IRS Code and ERISA, but no later than December, 31, 2010. IRS § 125 cafeteria plans includes cafeteria plans, Flexible Spending Arrangements (FSA), and Health Reimbursement Arrangements (HRA).

Expansion of coverage to children under age 27 applies to active and retiree health care plans, Voluntary Employee Benefit Associations (VEBA), as well as to self-employed taxpayers who may otherwise qualify for a self-employed health care insurance deduction under their Federal income tax.

Current Treasury Regulations do not permit IRS § 125 plan participants from making mid-year election changes expect under certain and limited circumstances. However, the IRS plans to amend retroactively current regulations to March 30, 2010, allowing for changes in status events affecting children under age 27.

The release further clarifies that for purposes of FICA, FUTA, RRTA, and income tax withholding treatment, income associated with IRS § 125 plans for children under age 27 is excludable from Federal taxation. However, employers should consult with their tax advisors and/or attorneys on issues of local and/or state taxation. The IRS has not issued any age limit, residency, support, or other test for these purposes other than the employee’s child must be under age 27 and the individual must meet the IRS definition of a legal child of the employee. Generally, this includes natural born children of the employee, adopted children, stepchildren, foster children, and children for whom the employee has court ordered and legal custody.

Employers should consider communicating with current employees as soon as it is administratively feasible in an effort to streamline the enrollment process through their websites or outsourced benefit vendors or plan carriers. Such communications should include documentation requirements including, birth certificates, adoption papers, and court orders. Since coverage is effective March 30, 2010, employers will need to consult with their carriers on retroactive enrollment options as well as retroactive payroll deductions if changes in premium amounts result. Employee new hire communications materials, handbooks, benefits websites, and Summary Plan Descriptions will require updating. Employers should consult with their legal advisors on issues related to plan amendments, Summary Plan Descriptions, Summary Material Modifications, and related plan compliance issues.