IRS Notice 2010-38 confirms that health coverage for children under age 27 can be excluded from an employee’s gross income, regardless of the age limit, residency, support, and other tests used to define a dependent in IRC Sec. 152. The notice, which provides guidance on Sec. 1004(d)(1) of the Patient Protection and Affordable Care Act, P.L. No. 111-148, is effective March 30, 2010.
“These changes give employers a unique opportunity to offer a worthwhile benefit to their employees,” IRS Commissioner Doug Shulman said. “We want to make it as easy as possible for employers to quickly implement this change and extend health coverage on a tax-favored basis to older children of their employees.”
General Provisions
According to the Affordable Care Act, employees who have children who will not have reached age 27 by the end of the year are eligible for the new tax benefit from March 30, 2010, forward, if the children are already covered under the employer’s plan or are added to the employer’s plan at any time. For this purpose, a child includes a son, daughter, stepchild, adopted child or eligible foster child (IRC Sec. 152(f)). This new age 27 standard replaces the lower age limits that applied under prior tax law, as well as the requirement that a child generally qualify as a dependent for tax purposes.
According to the notice, the exclusion applies only for reimbursements for medical care of individuals who are not age 27 or older at any time during the taxable year. For example, a child born on Dec. 10, 1985, attains age 27 on Dec. 10, 2012. For this individual, the new tax exclusion is available only through 2011. Employers may rely on the employee’s representation as to the child’s date of birth.
Examples
The notice provides several examples of how the new provision works, including these:
Example (1). JJ Sporting provides health care coverage for its employees and their spouses and dependents and for any employee’s child who has not attained age 26. For the 2010 taxable year, JJ Sporting provides coverage to employee Daniel Keyes and his son Chris. Chris will attain age 26 on Nov. 15, 2010. During the 2010 taxable year, Chris is not a full-time student. Chris has never worked for JJ Sporting. Chris is not a dependent of Daniel because prior to the close of the 2010 taxable year Chris had attained age 19 (and was also not a student who had not attained age 24).
Chris is a child of Daniel within the meaning of IRC Sec. 152(f)(1). Because Chris will not attain age 27 during the 2010 taxable year, the health care coverage and reimbursements provided to him under the terms of JJ Sporting’s plan are excludible from Daniel’s gross income for the period on and after March 30, 2010 through Nov. 15, 2010 (when Chris attains age 26 and loses coverage under the terms of the plan.
Example (2). WhyNot, Inc., provides health care coverage for its employees and their spouses and dependents and for any employee’s child who has not attained age 27 as of the end of the taxable year. For the 2010 taxable year, WhyNot, Inc., provides health care coverage to Employee Edwina Noise and to her son, George. George will not attain age 27 until after the end of the 2010 taxable year. During the 2010 taxable year, George earns $50,000 per year, and does not live with Edwina. George has never worked for WhyNot, Inc. George is not eligible for health care coverage from his own employer. George is not a dependent of E because George does not live with Edwina, and Edwina does not provide more than one half of his support.
George is a child of Edwina within the meaning of § 152(f)(1). Accordingly, and because George will not attain age 27 during the 2010 taxable year, the health care coverage and reimbursements for George under WhyNot, Inc.’s plan are excludible from Edwina’s gross income for the period on and after March 30, 2010 through the end of the 2010 taxable year.
Effects On Sec. 125
Sec. 125 cafeteria plan regulations currently do not permit election changes for children under age 27 who are not the employee’s dependents. According to the notice, the IRS intend to amend the regulations under IRC Sec. 1.125-4, effective retroactively to March 30, 2010, to include change in status events affecting nondependent children under age 27, including becoming newly eligible for coverage or eligible for coverage beyond the date on which the child otherwise would have lost coverage.
The same rules for employee’s child under age 27 apply to a health reimbursement arrangement (HRA), an arrangement that is paid for solely by an employer (and not through a § 125 cafeteria plan) and which reimburses an employee for medical care expenses up to a maximum dollar amount for a coverage period.
Cafeteria plans may need to be amended to include employees’ children who have not attained age 27 as of the end of the taxable year. In general, cafeteria plan amendments may be effective only prospectively. However, the notice provides that, as of March 30, 2010, employers may permit employees to immediately make pre-tax salary reduction contributions for accident or health benefits under a cafeteria plan (including a health FSA) for children under age 27, even if the cafeteria plan has not yet been amended to cover these individuals. However, a retroactive amendment to a cafeteria plan to cover children under age 27 must be made no later than Dec. 31, 2010, and must be effective retroactively to the first date in 2010 when employees are permitted to make pre-tax salary reduction contributions to cover children under age 27.
VEBAs, Sec. 401(h) Accounts, And Sec. 162(l) Deductions
The notice states that the same general rules for providing a tax exclusion to children under age 27 applies to these provisions:
- Voluntary employee beneficiary associations (VEBAs) providing for the payment of sick and accident benefits to members;
- IRC Sec. 401(h) accounts that provide for the payment of benefits for sickness, accident, hospitalization, and medical expenses;
- IRC Sec. 162(l), which allows self-employed individuals to deduct, amounts paid during the taxable year for insurance that constitutes medical care.
Requirement To Provide Coverage
The Affordable Care Act also added Sec. 2714 to the Public Health Service Act to require group health plans and health insurance issuers that provide dependent coverage of children to continue to make such coverage available for an adult child until age 26.
According to Notice 2010-38, “in certain respects, the rules of Sec. 2714 of the PHS Act extending coverage to an adult child do not parallel the gross income exclusion rules provided by the Affordable Care Act’s amendments…. For example, Sec. 2714 of the PHS Act 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 addressed in this Notice apply to children who have not attained age 27 as of the end of the taxable year and are effective March 30, 2010.”
Guidance regarding PHSA Sec. 2714 has not yet been issued.
For more information on Notice 2010-38, contact Karen Levin of the Office of Division Counsel/Associate Chief Counsel (Tax Exempt and Government Entities), (202) 622-6080.
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