IRS Comes Through With Language For Adult Children

Part III – Administrative, Procedural, and Miscellaneous
Section 105 – Amounts Received Under Accident and Health Plans (Also
Sections 106-Contributions by Employers to Accident and Health Plans, 162(l)-
Special Rules for Health Insurance Costs of Self-Employed Individuals, 401(h)-
Medical, Etc. Benefits for Retired Employees and Their Spouses and
Dependents, 501(c)(9)-Voluntary Employees’ Beneficiary Association, 3121-
Definitions, 3231-Definitions, 3306-Definitions, 3402-Income Tax Collected at
Source).
Tax Treatment of Health Care Benefits Provided With Respect to Children Under
Age 27
Notice 2010-38
I. PURPOSE
This Notice provides guidance on the tax treatment of health coverage for
children up to age 27 under the Affordable Care Act. (In this Notice, the
"Affordable Care Act" refers to the Patient Protection and Affordable Care Act,
Public Law No. 111-149 (PPACA), and the Health Care and Education
Reconciliation Act of 2010, Public Law No. 111-152 (HCERA), signed into law by
the President on March 23 and 30, 2010, respectively.)
The Affordable Care Act requires 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. The Affordable Care Act also
amends the Internal Revenue Code (Code) to give certain favorable tax
treatment to coverage for adult children. This Notice addresses a number of
questions regarding the tax treatment of such coverage.
Specifically, this Notice provides guidance on the Affordable Care Act’s
amendment of § 105(b) of the Code, effective March 30, 2010, to extend the
general exclusion from gross income for reimbursements for medical care under
an employer-provided accident or health plan to any employee’s child who has
not attained age 27 as of the end of the taxable year. (See § 1004(d) of HCERA.)
The Affordable Care Act also makes parallel amendments, effective March 30,
2010, to § 401(h) for retiree health accounts in pension plans, to § 501(c)(9) for
voluntary employees’ beneficiary associations (VEBAs), and to § 162(l) for
deductions by self-employed individuals for medical care insurance. (See §
1004(d) of HCERA.)
The Affordable Care Act amended the Public Health Service Act (PHS
Act) to add § 2714, which requires 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. (See § 1001 of PPACA.)
Section 2714 of the PHS Act is incorporated into § 9815 of the Code by § 1562(f)
of PPACA. In certain respects, the rules of § 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 of §§ 105(b), 401(h),
501(c)(9), and 162(l) of the Code. For example, § 2714 of the PHS Act applies to
children under age 26 and is effective for the first plan year beginning on or after
September 23, 2010, while, as noted above, 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.
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II. EXCLUSION OF EMPLOYER-PROVIDED MEDICAL CARE
REIMBURSEMENTS FOR EMPLOYEE’S CHILD UNDER AGE 27
Section 105(b) generally excludes from an employee’s gross income
employer-provided reimbursements made directly or indirectly to the employee
for the medical care of the employee, employee’s spouse or employee’s
dependents (as defined in § 152 (determined without regard to §152(b)(1), (b)(2)
or (d)(1)(B)). As amended by the Affordable Care Act, the exclusion from gross
income under §105(b) is extended to employer-provided reimbursements for
expenses incurred by the employee for the medical care of the employee’s child
(within the meaning of § 152(f)(1)) who has not attained age 27 as of the end of
the taxable year. (The Affordable Care Act does not alter the existing definitions
of spouse or dependent for purposes of § 105(b).) Under § 152(f)(1), a child is
an individual who is the son, daughter, stepson, or stepdaughter of the
employee, and a child includes both a legally adopted individual of the employee
and an individual who is lawfully placed with the employee for legal adoption by
the employee. Under § 152(f)(1), a child also includes an “eligible foster child,”
defined as an individual who is placed with the employee by an authorized
placement agency or by judgment, decree, or other order of any court of
competent jurisdiction.
As amended by the Affordable Care Act, the exclusion from gross income
under § 105(b) applies with respect to an employee’s child who has not attained
age 27 as of the end of the taxable year, including a child of the employee who is
not the employee’s dependent within the meaning of § 152(a). Thus, the age
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limit, residency, support, and other tests described in § 152(c) do not apply with
respect to such a child for purposes of § 105(b).
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
purposes of §§ 105(b) and 106, the taxable year is the employee’s taxable year;
employers may assume that an employee’s taxable year is the calendar year; a
child attains age 27 on the 27th anniversary of the date the child was born (for
example, a child born on April 10, 1983 attained age 27 on April 10, 2010); and
employers may rely on the employee’s representation as to the child’s date of
birth.
III. EXCLUSION OF EMPLOYER-PROVIDED ACCIDENT OR HEALTH
COVERAGE FOR EMPLOYEE’S CHILD UNDER AGE 27
Section 106 excludes from an employee’s gross income coverage under
an employer-provided accident or health plan. The regulations under § 106
provide that the exclusion applies to employer-provided coverage for an
employee and the employee’s spouse or dependents (as defined in § 152,
determined without regard to § 152(b)(1), (b)(2) or (d)(1)(B)). See Prop. Treas.
Reg. § 1.106-1. Prior to the Affordable Care Act, the exclusion for employerprovided
accident or health plan coverage under § 106 paralleled the exclusion
for reimbursements under § 105(b). There is no indication that Congress
intended to provide a broader exclusion in § 105(b) than in § 106. Accordingly,
IRS and Treasury intend to amend the regulations under § 106, retroactively to
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March 30, 2010, to provide that coverage for an employee’s child under age 27 is
excluded from gross income. Thus, on and after March 30, 2010, both coverage
under an employer-provided accident or health plan and amounts paid or
reimbursed under such a plan for medical care expenses of an employee, an
employee’s spouse, an employee’s dependents (as defined in § 152, determined
without regard to §152(b)(1), (b)(2) or (d)(1)(B)), or an employee’s child (as
defined in § 152(f)(1)) who has not attained age 27 as of the end of the
employee’s taxable year are excluded from the employee’s gross income.
The following examples illustrate this rule. In these examples, any
reference to a “dependent” means a dependent as defined in § 152, determined

without regard to §152(b)(1), (b)(2) or (d)(1)(B). Also, in these examples, it is
assumed that none of the individuals are disabled.
Example (1). (i) Employer X provides health care coverage for its
employees and their spouses and dependents and for any employee’s child (as
defined in § 152(f)(1)) who has not attained age 26. For the 2010 taxable year,
Employer X provides coverage to Employee A and to A’s son, C. C will attain age
26 on November 15, 2010. During the 2010 taxable year, C is not a full-time
student. C has never worked for Employer X. C is not a dependent of A
because prior to the close of the 2010 taxable year C had attained age 19 (and
was also not a student who had not attained age 24).
(ii) C is a child of A within the meaning of § 152(f)(1). Accordingly, and
because C will not attain age 27 during the 2010 taxable year, the health care
coverage and reimbursements provided to him under the terms of Employer X’s
plan are excludible from A’s gross income under §§ 106 and 105(b) for the period
on and after March 30, 2010 through November 15, 2010 (when C attains age 26
and loses coverage under the terms of the plan).
Example (2). (i) Employer Y provides health care coverage for its
employees and their spouses and dependents and for any employee’s child (as
defined in § 152(f)(1)) who has not attained age 27 as of the end of the taxable
year. For the 2010 taxable year, Employer Y provides health care coverage to
Employee E and to E’s son, G. G will not attain age 27 until after the end of the
2010 taxable year. During the 2010 taxable year, G earns $50,000 per year, and
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does not live with E. G has never worked for Employer Y. G is not eligible for
health care coverage from his own employer. G is not a dependent of E because
G does not live with E and E does not provide more than one half of his support.
(ii) G is a child of E within the meaning of § 152(f)(1). Accordingly, and
because G will not attain age 27 during the 2010 taxable year, the health care
coverage and reimbursements for G under Employer Y’s plan are excludible from
E’s gross income under §§ 106 and 105(b) for the period on and after March 30,
2010 through the end of the 2010 taxable year.
Example (3). (i) Same facts as Example (2), except that G’s employer
offers health care coverage, but G has decided not to participate in his
employer’s plan.
(ii) G is a child of E within the meaning of § 152(f)(1). Accordingly, and
because G will not attain age 27 during the 2010 taxable year, the health care
coverage and reimbursements for G under Employer Y’s plan are excludible from
E’s gross income under §§ 106 and 105(b) for the period on and after March 30,
2010 through the end of the 2010 taxable year.
Example (4). (i) Same facts as Example (3), except that G is married to H,
and neither G nor H is a dependent of E. G and H have decided not to
participate in the health care coverage offered by G’s employer, and Employer Y
provides health care coverage to G and H.
(ii) G is a child of E within the meaning of § 152(f)(1). Accordingly, and
because G will not attain age 27 during the 2010 taxable year, the health care
coverage and reimbursements for G under Employer Y’s plan are excludible from
E’s gross income under §§ 106 and 105(b) for the period on and after March 30,
2010 through the end of the 2010 taxable year. The fair market value of the
coverage for H is includible in E’s gross income for the 2010 taxable year.
Example (5). (i) Employer Z provides health care coverage for its
employees and their spouses and dependents. Effective May 1, 2010, Employer
Z amends the health plan to provide coverage for any employee’s child (as
defined in § 152(f)(1)) who has not attained age 26. Employer Z provides
coverage to Employee F and to F’s son, K, for the 2010 taxable year. K will
attain age 22 in 2010. During the 2010 taxable year, F provides more than one
half of K’s support. K lives with F and graduates from college on May 15, 2010
and thereafter is not a student. K has never worked for Employer Z. Prior to K’s
graduation from college, K is a dependent of F. Following graduation from
college, K is no longer a dependent of F.
(ii) For the 2010 taxable year, the health care coverage and
reimbursements provided to K under the terms of Employer Z’s plan are
excludible from F’s gross income under §§ 106 and 105(b). For the period
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through May 15, 2010, the reimbursements and coverage are excludible
because K was a dependent of F. For the period on and after March 30, 2010,
the coverage is excludible because K is a child of F within the meaning of §
152(f)(1) and because K will not attain age 27 during the 2010 taxable year.
(Thus, for the period from March 30 through May 15, 2010, there are two bases
for the exclusion.)
IV. CAFETERIA PLANS, FLEXIBLE SPENDING ARRANGEMENTS, AND
HEALTH REIMBURSEMENT ARRANGEMENTS
Section 125 allows employees to elect between cash and certain qualified
benefits, including accident or health plans (described in § 106) and health
flexible spending arrangements (health FSAs) (described in § 105(b)). Section
125(f) defines “qualified benefit” as any benefit which, with the application of §
125(a), is not includible in the gross income of the employee by reason of an
express provision of chapter 1 of the Code (other than §§ 106(b) (which applies
to Archer MSAs), 117, 127, or 132). Accordingly, the exclusion of coverage and
reimbursements from an employee’s gross income under §§ 106 and 105(b) for
an employee’s child who has not attained age 27 as of the end of the employee’s
taxable year carries forward automatically to the definition of qualified benefits for
§ 125 cafeteria plans, including health FSAs. Thus, a benefit will not fail to be a
qualified benefit under a cafeteria plan (including a health FSA) merely because
it provides coverage or reimbursements that are excludible under §§ 106 and
105(b) for a child who has not attained age 27 as of the end of the employee’s
taxable year.
A cafeteria plan may permit an employee to revoke an election during a
period of coverage and to make a new election only in limited circumstances,
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such as a change in status event. See Treas. Reg. § 1.125-4(c). A change in
status event includes changes in the number of an employee’s dependents. The
regulations under § 1.125-4(c) currently do not permit election changes for
children under age 27 who are not the employee’s dependents. IRS and
Treasury intend to amend the regulations under § 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.
In general, a health reimbursement arrangement (HRA) is an arrangement
that is paid for solely by an employer (and not through a § 125 cafeteria plan)
which reimburses an employee for medical care expenses up to a maximum
dollar amount for a coverage period. Notice 2002-45, 2002-2 C.B. 93. The same
rules that apply to an employee’s child under age 27 for purposes of §§ 106 and
105(b) apply
to an HRA.
V. FICA, FUTA, RRTA, AND INCOME TAX WITHHOLDING TREATMENT
Coverage and reimbursements under an employer-provided accident and
health plan for employees generally and their dependents (or a class or classes
of employees and their dependents) are excluded from wages for Federal
Insurance Contributions Act (FICA) and Federal Unemployment Tax Act (FUTA)
tax purposes under §§ 3121(a)(2) and 3306(b)(2), respectively. For these
purposes, a child of the employee is a dependent. Treas. Reg. §§ 31.3121(a)(2)-
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1(c) and 31.3306(b)(2)-1(c). No age limit, residency, support, or other test
applies for these purposes. Thus, coverage and reimbursements under a plan
for employees and their dependents that are provided for an employee’s child
under age 27 are not wages for FICA or FUTA purposes. For this purpose, child
has the same meaning as in § 152(f)(1), as discussed in the first paragraph in
Section II of this Notice. A similar exclusion applies for Railroad Retirement Tax
Act (RRTA) tax purposes under § 3231(e)(1)(i) and Treas. Reg. § 31.3231(e)-
1(a)(1).
Such coverage and reimbursements are also exempt from income tax
withholding. See Rev. Rul. 56-632, 1956-2 C.B. 101.
VI. VEBAS, SECTION 401(h) ACCOUNTS, AND SECTION 162(l)
DEDUCTIONS
A VEBA is a tax-exempt entity described in § 501(c)(9) providing for the
payment of life, sick, accident, or other benefits to members of the VEBA or their
dependents or designated beneficiaries. The regulations provide that, for
purposes of § 501(c)(9), “dependent” means the member’s spouse; any child of
the member or the member’s spouse who is a minor or a student (within the
meaning of § 151(e)(4) (now § 152(f)(2)); any other minor child residing with the
member; and any other individual who an association, relying on information
furnished to it by a member, in good faith believes is a person described in §
152(a). Treas. Reg. § 1.501(c)(9)-3. As amended by the Affordable Care Act, §
501(c)(9) provides that, for purposes of providing for the payment of sick and
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accident benefits to members of the VEBA and their dependents, the term
dependent includes any individual who is a member’s child (as defined in §
152(f)(1)) and who has not attained age 27 as of the end of the calendar year.
Section 401(h) provides that a pension or annuity plan can establish and
maintain a separate account to provide for the payment of benefits for sickness,
accident, hospitalization, and medical expenses of retired employees, their
spouses and their dependents if certain enumerated conditions are met (“401(h)
Account”). The regulations provide that, for purposes of § 401(h) and § 1.401-14,
the term “dependent” shall have the same meaning as that assigned to it by §
152. Treas. Reg. § 1.401-14(b)(4)(i). As amended by the Affordable Care Act, §
401(h) provides that the term dependent includes any individual who is a retired
employee’s child (within the meaning of § 152(f)(1)) and who has not attained
age 27 as of the end of the calendar year.
Section 162(l) generally allows a self-employed individual to deduct, in
computing adjusted gross income, amounts paid during the taxable year for
insurance that constitutes medical care for the taxpayer, his or her spouse, and
dependents, if certain requirements are satisfied. As amended by the Affordable
Care Act, § 162(l) covers medical insurance for any child (within the meaning of §
152(f)(1)) who has not attained age 27 as of the end of the taxable year.
VII. TRANSITION RULE FOR CAFETERIA PLAN AMENDMENTS
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. Pursuant to §
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1.125-1(c) of the proposed regulations, cafeteria plan amendments may be
effective only prospectively. Notwithstanding this general rule, 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 December 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 (but in no event before March 30,
2010).
VIII. EFFECT ON OTHER DOCUMENTS
IRS and Treasury intend to amend the regulations at §§ 1.105-1, 1.105-2,
1.106-1, 1.125-1, 1.125-4, 1.125-5, and 1.401-14 to include children (as defined
in §152(f)(1)) who are under age 27. Additionally, IRS and Treasury intend to
amend the regulations at § 1.501(c)(9)-3 to include children (as defined in
§152(f)(1)) who are under age 27, with respect to sick and accident benefits.
Taxpayers may rely on this Notice pending the issuance of the amended
regulations.
IX. EFFECTIVE DATES
The changes relating to §§ 105(b), 106, 501(c)(9), 401(h) and 162(l) are
effective on March 30, 2010.
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DRAFTING INFORMATION
The principal author of this notice is Karen Levin of the Office of Division
Counsel/Associate Chief Counsel (Tax Exempt and Government Entities). For
further information regarding this notice, contact Ms. Levin at (202) 622-6080 (not
a toll-free call).

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