Friday, May 21, 2010

Tax-free treatment of health benefits for children under age 27 effective immediately

On April 27, the IRS issued Notice 2010-38, providing guidance on the tax exclusion for medical care reimbursement of adult children. These changes are a result of the recently enacted health reform legislation, collectively referred to in the notice as the Affordable Care Act.

The notice states that employers with cafeteria plans may permit employees to immediately make pre-tax salary reduction contributions to provide coverage for children under age 27, even if the cafeteria plan has not yet been amended with such a provision. Plan sponsors have until December 31, 2010 to amend cafeteria plan language to incorporate this change.

This immediate expansion will allow plan sponsors that wish to extend coverage to adult dependents now to do so without having to withhold additional federal taxes from employees to cover the value of the benefits if the amounts were deemed taxable income.

General Guidance from IRS Notice 2010-38
• The IRS will permit employers to amend their cafeteria plans retroactively to allow pre-tax salary reductions for adult children as long as the plan is amended by the end of 2010.
• The tax exclusion applies to employer-provided health coverage for an employee’s child who is not age 27 or older at any time during the calendar year.
• Employers may rely on an employee’s representation as to the child’s date of birth.
• For purposes of the tax exclusion, an adult child is defined as son/daughter, stepson/stepdaughter, adopted child or eligible foster child.
• Both married and unmarried adult children are eligible; however, the child’s spouse and/or children are ineligible.
• Plan participants who add an adult child dependent can increase their current year medical flexible spending account (FSA) elections due to current rules which allow election changes for change in status events.
• The tax exclusion expansion applies to plans that define eligibility based on Section 105(b), including medical FSAs and health reimbursement arrangements (HRAs).

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