IRS Provides Guidance on Health Coverage for Adult Dependents, Addresses Discrepancies in Law

The IRS issued guidance Tuesday on the tax treatment of health coverage for children who have not yet turned 27 (Notice 2010-38).

The health care reform legislation enacted in March extended the general exclusion from gross income for reimbursements for medical care under an employer-provided accident or health plan (under IRC § 105(b)) to any employee’s child who has not yet turned 27 by the end of the tax year. The legislation made a similar change for retiree health accounts in pension plans, voluntary employees’ beneficiary associations, and for deductions by self-employed individuals for medical insurance.

The health care legislation also requires group health plans and health insurers that provide dependent care coverage to continue to make such coverage available for an adult child until age 26. This requirement is not exactly parallel to the amendments to the Code. For example, it applies to children under age 26 and is effective for the first plan year beginning on or after Sept. 23, 2010, while the amendments to the Code apply to children who have not yet attained age 27 at the end of the tax year and are effective March 10, 2010.

While the health care reform legislation amended section 105(b), it did not amend section 106, which excludes from an employee’s gross income coverage under an employer-provided accident or health plan. The notice says that “[t]here is no indication that Congress intended to provide a broader exclusion in § 105(b) than in § 106” and says the IRS intends to amend the regulations under section 106—retroactively to March 30, 2010—to provide that coverage for an employee’s child under age 27 is excluded from gross income.

The notice also says that this change to the definition of qualified child in section 105 (and 106) automatically changes the definition of qualified benefits for cafeteria plans, including flexible spending arrangements (FSAs). Thus, a benefit will not fail to be a qualified benefit under a cafeteria plan just because it provides coverage or reimbursements that are excludible under section 105(b) or 106 for a child who has not yet turned 27. The notice says these rules also apply to health reimbursement arrangements (HRAs). The IRS says that cafeteria plans can allow employees to immediately make pre-tax salary reduction contributions for children under 27, even if the cafeteria plan has not yet been formally amended to provide for them.

The notice also says that coverage and reimbursements provided for an employee’s child under age 27 are not wages for FICA or FUTA purposes and are exempt from income tax withholding.