Adult Child Taxation Issues Change Under New Health Care Bill

By Ric Joyner, MBA, CEBS, CFCI

The new Health Care bill changes the taxation issues of Adult Child Premiums for the better. Many states have mandated that adult children can be covered until age 27 (WI). The issues for employers and HR administrators are, “what are the taxes associated with adult child premiums?”, “how do we administer and communicate the taxes to employees?”, “what benchmark do we use to find the fair market value for adult child premiums?” and finally “how do we apply imputed income?”. The result of state mandates for adult child premiums area that employees who extends coverage to their adult children will pay the taxes on the premiums. In some cases, it is helpful for HR to allow employees with adult child premiums to purchase individual policies versus extending coverage. The individual premiums can be significantly cheaper however, please note that underwriting can be more stringent on individual policies.

With passage of the new health care bill, the burden on HR has changed for adult child premiums. Federal law will supersedes state law, and many of the burdens for HR lessen because, as we will see, the employee can extend coverage to adult children and pay for it with tax free dollars. Prior to the new health care bill, when a State would mandate health insurance coverage extension to adult children (e.g. to age 27) the employee who extends coverage to their adult child  is required to pay the taxes on the coverage. The employer is also required to find the fair market value for the cost of the premium. Once the premium is calculated, the employee is required to pay taxes on the premiums. We created a seminar on how to handle adult child premiums regarding the tax consequences, and you are welcome to listen.

Here is language from the Reinhart Law Firm, Todd Martin, JD which describes the new changes for adult child premiums in the new Health Care regs.

Any group health plan or health insurer must extend dependent coverage under an individual or group health plan for unmarried children until the child turns 26.  (PHSA §2714(a) added by Health Care Act §1001(5))  This section does not mandate dependent coverage, but requires the extension if any dependent coverage is offered.  Failure to do so will subject the coverage to an excise tax. 

The tax issues with adult child premiums are changed by this language and the premiums are now tax free for the employee. Great news!

The new law also extends exclusion from income for health coverage provided to any child of a participant who is under age 27 as of the end of the tax year, even if the child is not a dependent for tax purposes. (Code §105(b) amended by 2010 Reconciliation Action §1004(d)(1))This exclusion also applies to amounts paid for coverage that constitutes medical care by a self-employed individual for a child under age 27 as of the end of the tax year.   (Code §162(l)(1) amended by 2010 Reconciliation Action §1004(d)(2)).  This exclusion from tax applies even if the child is married. 

The following is a new HR list I prepared for implementation of the adult child premiums including timelines. For example, within 6 months of signing the employee can move adult child premiums pre-tax.

1. Employees who offer adult child premiums to their children can pay with tax free dollars.  The result is that employers can use their section 125, “premium only plan” to pay the premiums using pre-tax dollars. Plan documents are required to be amended to allow adult child premiums. Note; for eflex clients, the documents are automatically updated.

2. HR and insurance agents should note that the employee is not required to extend coverage to the dependents of the adult child. In other words, if an adult child is married and under 27, the employee could extend coverage to the adult child, but not to their spouse or children.

3. Adult Children can be married and still receive the benefit.

4. It may be advantageous to suggest employees seek individual policies. And if the employee chooses to purchase an individual policy for their adult child, the section 125 plan can be amended to allow for reimbursement through a separate FSA created to allow for “paid at home” insurance premiums.

5. EXTENDS COVERAGE FOR YOUNG PEOPLE UP TO 26TH BIRTHDAY THROUGH PARENTS’ INSURANCE – Requires health plans to allow young people up to their 26th birthday to remain on their parents’ insurance policy, at the parents’ choice. Effective 6 months after enactment. (Source: Speaker Pelosi’s web site)

6. Please be aware that there is a 6 month window where the employees will still pay the taxes on the adult child premiums until the new law is in effect. Once the new law is re-signed by the President, and after the 6 month waiting period,  employees can pre-tax this benefit under section 125.

The new regs should help with the administration of adult child premiums now that section 105 allows for pre-tax premiums.