December 16, 2010 -- As 2010 comes to a close, issues relating to the taxability of health coverage provided to older-aged dependents must be pondered. As part of the Patient Protection and Affordable Care Act, health plans that provide coverage for dependents must allow a dependent child to remain on the plan until he/she reaches his/her 26th birthday (see CBIZ Bulletin, Health Reform's Coverage for Dependent Children Explained). Part of the Reconciliation law provides that the cost of health coverage for older-aged dependents is not includible in the employee’s income (see CBIZ Bulletin, IRS Guidance: Tax-Favored Status of Dependent Coverage). Therefore, for federal tax purposes, the issues are relatively straight forward.
States Conforming to Federal Tax Law
Some states automatically follow the tax treatment imposed by federal law. In these particular states, the cost of health coverage for older-aged dependents will not be subject to state tax; these states are:
Alabama, Colorado, Connecticut, Delaware, Illinois, Kansas, Louisiana, Maryland, Michigan, Missouri, Montana, Nebraska, New Mexico, New York, North Carolina, North Dakota, Ohio, Oklahoma, Pennsylvania, Rhode Island, Utah, Vermont, and Washington, DC.
In states that do not automatically follow the federal law, state income taxes (not federal), would have to be imputed into an employee’s income if the covered older-aged child does not meet the definition of dependent in that particular state. States that have yet to change their tax laws to parallel or conform to the federal tax law are:
Arizona, Arkansas, California, Georgia, Hawaii, Idaho, Indiana, Iowa, Kentucky, Maine, Massachusetts, Minnesota, Oregon, South Carolina, Virginia, West Virginia, and Wisconsin.
To date, only three of these states have addressed the issue of state income tax treatment of dependent coverage:
In California, legislation would have to be enacted to conform the state tax law to the federal law; therefore, the cost of providing coverage to older-aged dependents would be includible in the employee’s income and subject to state tax (see pages 126-130 of Summary of Federal Health Care Acts -- 2010 from the California Franchise Tax Board)
Minnesota. Currently, Minnesota tax law requires employers to withhold the “fair market value of insurance benefits provided to nondependent adult children of employees”. Until the Legislature reconvenes in January, 2011 to enact legislation that would conform Minnesota tax law to the federal law, the Minnesota Department of Revenue will not require employers to withhold taxes from these federally exempt employer benefits provided in the 2010 tax year. For further recommendations on how to process these amounts, both from and employer and employee stand-point, see Employer provided health insurance and adoption benefits from the Minnesota Department of Revenue’s publication, What’s new for employers for tax year 2010?
Wisconsin. Similarly, until the Wisconsin Legislature enacts legislation to conform its state tax law to the federal tax law, the cost of providing coverage to a child under age 27 would be includible in the employee’s income unless the child meets the federal definition of "qualifying child" or "qualifying relative". For details, see Tax Information Relating to Health Care Benefits for Children Under Age 27 from the Wisconsin Department of Revenue.
What Should An Employer Do?
As year-end payrolls are being completed and Form W-2s are being prepared, employers should work with the payroll and tax advisers to make certain that all appropriate taxes are imposed.
Consider utilizing an affidavit or certification of dependent status in states that do not follow the federal law. The affidavit/certification should reflect the definition of dependent for tax purposes in the particular state. See pages 3-4 of this Bulletin for a sample affidavit/certification that uses the federal definition of qualifying child and qualifying relative; many states use this definition.
About the Author: Karen R. McLeese is Vice President of Employee Benefit Regulatory Affairs for CBIZ Benefits & Insurance Services, Inc., a division of CBIZ, Inc. She serves as in-house counsel, with particular emphasis on monitoring and interpreting state and federal employee benefits law. Ms. McLeese is based in the CBIZ Leawood, Kansas office.
The information contained herein is not intended to be legal, accounting, or other professional advice, nor are these comments directed to specific situations. The information contained herein is provided as general guidance and may be affected by changes in law or regulation. This information is not intended to replace or substitute for accounting or other professional advice. You must consult your own attorney or tax advisor for assistance in specific situations. This information is provided as-is, with no warranties of any kind. CBIZ shall not be liable for any damages whatsoever in connection with its use and assumes no obligation to inform the reader of any changes in laws or other factors that could affect the information contained herein. As required by U.S. Treasury rules, we inform you that, unless expressly stated otherwise, any U.S. federal tax advice contained herein is not intended or written to be used, and cannot be used, by any person for the purpose of avoiding any penalties that may be imposed by the Internal Revenue Service.
Very Important Note: This form is a sample only. It must be revised to comply with the terms of your plan, or your particular situation or circumstances. Your legal counsel should review this document before it is used.
SAMPLE AFFIDAVIT OF DEPENDENT STATUS
FOR TAX YEARS BEGINNING 1/1/09
For purposes of employer-sponsored group health coverage, if an individual does not meet the Federal tax definition of a dependent, then the fair market value of such dependent coverage would be includable in the employee’s income for Federal tax purposes.
The Federal tax definition of a dependent1 is one who meets the definition of either 1) a qualifying child, or 2) a qualifying relative:
Who is a Qualifying Child? For tax years beginning on or after January 1, 2009, a qualifying child for purposes of IRC §152 must meet the following criteria:
1. The individual is the taxpayer’s child or stepchild (whether by blood or adoption), foster child, sibling or stepsibling, or a descendant of one of these.
2. The individual resides for over 50% of the taxable year with the taxpayer.
3. The individual is younger than the taxpayer claiming the child, and either:
a. Under the age of 19 by the end of the calendar year;
b. A full-time student who has not attained age 24 by the close of the calendar year; or,
c. Permanently disabled, without regard to age.
4. The individual did not provide more than 50% of his/her own support for the year;
5. The individual cannot file a joint return (this means that most married children could not qualify as a qualifying child); and
6. If more than one person is eligible to claim the individual, and if no parent claims the individual, a non-parent can claim the individual as a ‘qualifying child’ as long as he/she has a higher adjusted gross income than any parent.
Who is a Qualifying Relative? A qualifying relative for purposes of IRC §152 must meet the following criteria:
1. The individual is a relative of the taxpayer, as defined in IRC §152(d); or other than a spouse, someone who has the same principal place of abode and is a member of the taxpayer’s household.
2. The taxpayer provides more than 50% of the individual’s total support for the year.
3. The individual is not a qualifying child of another taxpayer.
Certification of Dependent Status
I certify that the following dependent(s) meet the criteria of Qualifying Child or Qualifying Relative, as defined above:
[List names of dependents]
I certify that the following dependent(s) do not meet the criteria of Qualifying Child or Qualifying Relative, as defined above:
[List names of dependents]
I understand that if any of the dependents listed above do not meet the definition of qualifying child or qualifying relative, then he/she may be eligible for coverage under the following plan(s), in accordance with the terms of the particular plan(s). However, I agree to be responsible for paying any taxes imposed on the fair market value of such coverage:
[List plan names]
Signature of Employee
1 Special rules apply in the case of divorce.