Subject: Health Care Reform: IRS Notice 2010-38 and Exclusion from Taxation for Coverage of Adult Children
By Greg Storm, JD
Earlier today, the IRS issued Notice 2010-38 (linked below). The Notice addresses the tax treatment of health benefits provided to adult children through the year in which the child turns 26, expanding on the related provision found in PPACA/HCERA, a/k/a the "Health Reform Act."
Overall, the Notice does not offer a significant amount of insight beyond some straightforward interpretations and clarifications. Most notably, the Notice does not discuss any of the many outstanding issues related to PPACA’s mandatory coverage requirement for adult children up to age 26; the Notice addresses only the tax implications of providing that coverage. That said, the Notice might offer some indication as to how HHS will resolve some of the major questions on the mandatory coverage issue, assuming that HHS views issues similarly to the IRS. I mention highlights of the Notice and a few thoughts regarding potential interpretations for the mandatory coverage issue below.
1. The Notice states that the income exclusion provisions apply to any employee’s child meeting the age limit, regardless of whether the child is a dependent under Code section 152(a). Thus, the age limit, residency, support and other tests described in Code section 152(c) do not apply for these purposes. The Notice provides a number of examples, including one where, in 2010, an employer plan covers employees’ adult children who have not attained age 27 as of the end of the taxable year, and an employee has a child who is under age 27, does not live with the employee and who makes $50,000 in 2010. The coverage is not taxable to the employee in 2010. Note: If HHS interprets PPACA in a way that roughly follows the IRS’s lead, plans would no longer be able to impose residency, student, etc. requirements in drafting the mandatory coverage provisions. Much uncertainty still exists on this point, but as this item is the first piece of formal guidance regarding PPACA, I would expect commentators to note IRS’s treatment of the issue.
2. The Notice indicates that IRS will revise the regulations under Code section 106 (regarding coverage under an employer provided plan) to mirror PPACA’s income exclusion under Code section 105 (regarding employer provided reimbursements for medical care).
3. The Notice states that the same income exclusion provisions extend to cafeteria plans, FSAs and HRAs, through Code sections 105 and 106.
4. The Notice states that IRS intends to amend the cafeteria plan regulations retroactive to March 30, 2010 to include as "change in status" events those 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 Notice notes that cafeteria plans may permit employees to revoke elections and make new elections only in limited circumstances, such as change in status events. Change in status events include changes in the number of dependents, but the regulations do not currently allow election changes for children under age 27 who are not the employee’s dependents. Note: Again, if HHS follows a similar interpretive path for PPACA’s mandatory coverage provisions, HHS could require plans to provide new enrollment rights for adult children who previously lost plan coverage.
5. The Notice adds that the value of coverage and reimbursements for adult children through age 27 is also excluded from the employee’s wages for FICA & FUTA purposes, as well as being exempt from income tax withholding.
6. The Notice notes that cafeteria plan amendments are typically effective only on a prospective basis. However, if a cafeteria plan is amended to allow employees to make pre-tax contributions for children under age 27, employers may adopt cafeteria plan amendments on a retroactive basis. The retroactive amendments must be made no later than December 31, 2010, and must be retroactive to the first date on which employees may make pre-tax contributions (no sooner than March 30, 2010).
Feel free to let me know if you have any questions. We will continue to watch for further guidance on the numerous PPACA issues.