IRS PROVIDES CLARIFICATION REGARDING THE PATIENT PROTECTION AND AFFORDABLE CARE ACT

The Internal Revenue Service has issued guidance on the favorable tax treatment of health care coverage for employees’ nondependent adult children, to whom such coverage was extended under the Patient Protection and Affordable Care Act (“Patient Protection Act”). The Patient Protection Act requires that employer group health plans that provide for dependent coverage must continue to make such coverage available to employees’ adult children until age 26, regardless of the child’s student status and regardless of whether that child meets the definition of “dependent” under Sec. 152 of the Tax Code. This requirement is effective for plan years beginning on or after Sept. 23, 2010 (thus, for calendar year plans, starting with the plan year that begins Jan. 1, 2011). The favorable tax treatment addressed in Notice 2010-38 is effective as of March 30, 2010, and applies to covered nondependent adult children who do not turn age 27 during the employee’s tax year. Employers may rely on what an employee tells them as to the adult child’s date of birth.

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What Notice 2010-38 does is to permit this favorable tax treatment to apply beginning March 30, 2010, to employees in plans that had already allowed coverage of nondependent adult children, but which were imputing income to employees to account for the coverage. It also permits the favorable tax treatment for plans that voluntarily expand coverage to nondependent adult children in advance of the date required by the Patient Protection Act.

The clarifications and guidance in IRS Notice 2010-38 include the following:

  • An adult child who is employed elsewhere, and who is eligible for coverage through that employer but declines it, still may be covered on a tax-free basis under a parent’s plan, so long as he or she has not turned age 27 by the end of the year. (Note that the Patient Protection Act grandfathers plans in existence on March 23, 2010, so that these plans are not required to offer coverage to adult children who are eligible for coverage at their current employer. If a plan chooses to extend coverage to these individuals, the coverage is tax-free to the employee so long as the child has not turned 27 in the tax year.)
  • An adult child who is married still may be covered on a tax-free basis under a parent’s plan, so long as he or she has not turned age 27 by the end of the year. If the adult child’s spouse also were covered, that coverage would not receive the favorable tax treatment, and the employer would be required to impute income to the employee reflecting the value of the spouse’s coverage.
  • The exclusion applies to employee pre-tax contributions for health plan coverage under a cafeteria plan, as well as to health plan flexible spending account reimbursements and to employer-provided health reimbursement arrangements (HRAs). The notice states that the IRS will be amending cafeteria plan election change regulations retroactively to March 30 to allow changes for adult children under age 27 becoming newly eligible for coverage, or becoming eligible for coverage beyond the date the adult child otherwise would have lost it. Thus, a plan that chooses to allow employees to cover nondependent adult children in 2010 can permit employees to make election changes in order to do this on a pre-tax basis, or to make an FSA change to reflect the addition of the adult child. Employers that opt for this must amend plans by Dec. 31, 2010, to reflect this change.
  • As noted above, for purposes of the tax exclusion, the adult child need not be a “dependent” of the employee. “Child” means an individual who is a son, daughter, stepson, stepdaughter, legally adopted individual, individual placed with the employee for adoption, or foster child.

Consult with our plan providers and benefits professionals to help determine the plan amendments and communications necessary to comply with the Patient Protection Act and to ensure employees receive the favorable tax treatment for coverage of nondependent adult children now provided by the Tax Code.

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