IRS Issues Guidelines on Nontaxable Adult-Child Coverage



A "child" includes a son, daughter, stepchild, adopted child or eligible foster child, regardless of whether they are a dependent under the tax code

By Stephen Miller Apr 28, 2010

As a result of changes made by the Patient Protection and Affordable Care Act that became law in March 2010, health coverage provided for an employee's children under 27 years of age is now generally tax-free to the employee, effective March 30, 2010, according to the Internal Revenue Service.

The IRS announced on April 27, 2010, that these changes allow employers with cafeteria plans––plans that allow employees to choose from a menu of tax-free benefit options and cash or taxable benefits––to permit employees to begin making pretax contributions to pay for this expanded benefit.

IRS Notice 2010-38 explains these changes and provides further guidance to employers, employees, health insurers and other interested taxpayers.

“These changes give employers a unique opportunity to offer a worthwhile benefit to their employees,” IRS Commissioner Doug Shulman said. “We want to make it as easy as possible for employers to quickly implement this change and extend health coverage on a tax-favored basis to older children of their employees.”

In the guidance, the IRS explained that employers may provide tax-free medical coverage to children up to age 27. "This tax-free guidance should not be confused with the new health care requirement to provide coverage to dependent children up to age 26. The [reform act] changes to the Public Health Service Act do not parallel the changes to the Internal Revenue Code," explained Frank Palmieri, founding attorney of the law firm Palmieri & Eisenberg, in an alert issued by his firm.

Specifically, the guidance clarifies that:

The changes to the Public Health Service Act serve to extend coverage to children up to age 26 effective for plan years beginning on or after Sept. 23, 2010.

The Internal Revenue Code creates an income tax exclusion for children under age 27 as of the end of a taxable year, effective as of March 30, 2010.

This expanded health care tax benefit applies to various workplace and retiree health plans. It applies to self-employed individuals who qualify for the self-employed health insurance deduction on their federal income tax return.

Employees who have children who will not have reached age 27 by the end of the year are eligible for the new tax benefit from March 30, 2010, forward, if the children are already covered under the employer’s plan or are added to the employer’s plan at any time.

Moreover, the IRS clarified that:

For this purpose, a child includes a son, daughter, stepchild, adopted child or eligible foster child. This new age 27 standard replaces the lower age limits that applied under prior tax law, as well as the requirement that a child generally qualify as a dependent for tax purposes.

Employers with cafeteria plans may permit employees to immediately make pretax salary reduction contributions to provide coverage for children under age 27, even if the cafeteria plan has not yet been amended to cover these individuals. Plan sponsors then have until the end of 2010 to amend their cafeteria plan language to incorporate this change.

In addition, the Patient Protection and Affordable Care Act require plans that provide dependent coverage of children to continue to make the coverage available for an adult child until the child turns age 26. The extended coverage must be provided not later than plan years beginning on or after Sept. 23, 2010. The favorable tax treatment described in the notice applies to that extended coverage.

Information on other health care provisions can be found on this web site, www.IRS.gov.

FSA and Coverage Issues

According to an alert issued by the law firm Palmieri & Eisenberg, important issues to consider regarding the new IRS guidelines include:

The new tax exclusion applies to coverage provided on or after March 30, 2010. Accordingly, coverage prior to March 30, 2010 is subject to taxation if an individual does not qualify as a dependent under the tax code, in the same manner as income is “imputed” for domestic partners.

The exclusion only applies to coverage in the tax year “before” the child turns age 27. Thus, if a child turns age 27 in 2011, the tax exclusion ceases to apply effective as of Dec. 31, 2010.

Changes will be permitted under health flexible spending accounts (FSAs) to allow employees to pay for the cost of existing or new coverage on a pretax basis even if the FSA plans are not immediately amended to allow “mid-year” changes in status.

Employers will have until Dec. 31, 2010 to amend their FSA plans to provide for this coverage. Plan sponsors should consider preparing all necessary amendments when also amending their FSA plans to exclude over the counter prescription drugs for 2011 (except where such OTC drugs are prescribed by a physician or are for insulin).

The alert notes further that some insurance carriers are implementing dependent age 26 coverage prior to 2011. However, coverage is being implemented inconsistently between various carriers. For example, some carriers are allowing coverage for dependents up to age 26 for new hires in addition to continuing coverage for those dependents that would have aged out due to loss of full-time student status. Other carriers appear to only cover dependents that are currently graduating college. Therefore, the firm advises that employers who maintain multiple health plans may wish to wait until Jan. 1, 2011, to introduce consistent coverage for adult children up to age 26.


Stephen Miller is an online editor/manager for SHRM.​

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