Today the IRS issued the first installment of what is expected to be an avalanche of guidance on the new health care reform law. The guidance confirms that an employer-sponsored health plan may provide coverage free from federal income tax to an employee’s children up to age 27.

This exclusion applies regardless of whether the child is married and regardless of whether the child is regarded as a “dependent” under the Internal Revenue Code.

The gross income exclusion is subject to certain caveats, including the following:

  • The exclusion is effective for health coverage provided on or after March 30, 2010. Before March 30, coverage for the child will be excludable only if the child qualifies as a tax-code dependent.
  • The exclusion ceases to apply in the year in which the child turns 27. Thus, if a child will turn 27 on December 15, 2011, the exclusion applies to health coverage provided from March 30, 2010, through December 31, 2010.

Corresponding changes will be made to other regulatory requirements, including rules governing voluntary employees’ beneficiary associations (VEBAs), employment taxes under FICA and FUTA, and cafeteria plans. For example, midyear changes will be permitted under a cafeteria plan when an employee’s 25-year-old child has a change in status, even if the child no longer qualifies as the employee’s dependent for federal income tax purposes.

On January 1, 2011, most calendar-year health plans will need to comply with the new health care reform mandate to extend coverage to adult children up to age 26. Certain insurers have announced that they are preparing to implement this change earlier than required for certain adult dependents. A special transition rule allows an employee to contribute toward the cost of coverage for an adult child on a pre-tax basis under a cafeteria plan this year as long as the cafeteria plan is retroactively amended by December 31, 2010 (if an amendment is needed to encompass adult dependents). Although various questions still need to be answered about the new requirement to cover adult children, the change in tax rules does much to pave the way for the timely (and early) implementation of the mandate.

As the federal health care reform effort gained steam, Ballard Spahr attorneys formed an initiative to monitor and analyze legislative developments. With federal health care reform now a reality, our attorneys are assisting employers in understanding the relevant changes and planning for the future. For more information on the firm’s Health Care Reform Initiative, please click here.