Taxes Complicate Rule on Health Coverage for Adult Children

One provision of the new health care reform law is causing complex compliance challenges.  Some states require that employees pay taxes on the extended coverage for their adult children.  Employers must calculate and withhold the taxes from the employees’ paycheck.

The Internal Revenue Service had allowed tax-free coverage prior to the health care reform law for dependent children to age 19, or to age 24 if s/he was a full-time student.  Their new guideline allows employers to provide tax-free coverage to employees’ adult children to age 26 according to the new law.

However, “the extended coverage may be taxable under some states’ laws, with little guidance on how to calculate the tax liability.  Compounding the problem is that some states may amend their laws retroactively to eliminate the tax issue, but at this point no one knows which states will act.”

For example, California law sets a five-part test, all parts of which must be satisfied for the coverage to be excluded from employees’ taxable income.  Among other things, the child must be younger than 19, or 24 if a full-time student, and not provide for more than half of his or her own “support.”  As a result, if an employee added an adult child who did not satisfy the test, the portion of the insurance premium attributable to the child would be considered taxable wages and subject to California taxes, according to guidance by the California Employment Development Department.

However, “the precise value of the coverage and how much income would be added to employees’ W-2 wage and income statements isn’t clear and varies by state.”

In California, income attributed to the employee for coverage of a nondependent adult child would be the difference between the premium paid including that child and the premium paid without the child, according to the EDD.  But it isn’t clear how the calculations would be made if the health care plan were self-funded and no insurance premiums were paid.

The problem may ease as states pass legislation to make their state law conform with federal law regarding the tax treatment for health care coverage provided to employees’ adult children.  However, this may take some time.  Meanwhile, employers with employees in nonconforming states will have to decide how to comply with the tax issues.

From Business Insurance, February 14, 2011 issue, pp. 1 and 17.