Author: Filice Insurance Compliance Department
Many health plans provide coverage for dependent children of the plan’s participants. Traditionally, health plans have had significant flexibility in determining which individuals would be eligible to be covered as dependents. However, this flexibility is affected by the health care reform requirement to provide coverage up to age 26 and by some state laws.
Whether dependent coverage under a health plan is tax-free (at the federal level) depends on whether the individuals covered as dependents also qualify as dependents under the Internal Revenue Code (the Code or tax code). An individual can qualify as a dependent under the Code by being any one of the following:
- A child of the employee (until the end of the year in which the child turns 26)
- A qualifying child, as defined in Code Section 152
- A qualifying relative, as defined in Code Section 152
Before health care reform, an individual had to be either a qualifying child or qualifying relative to be a tax dependent for health plan purposes. Once health care reform was passed, the definition of tax dependent was extended, effective as of March 30, 2010, to include “any child (son, daughter, stepson, stepdaughter or an eligible foster child of the taxpayer) who as of the end of the taxable year has not attained age 27.”
Dependent Coverage under Health Care Reform
The Patient Protection and Affordable Care Act (PPACA) requires health plans and issuers that offer dependent coverage to children on their parents’ plans to make the coverage available until the child reaches the age of 26, effective on the first day of the first plan year on or after September 23, 2010. This rule applies to both married and unmarried children. Click here for health insurance quotes after age 26.
A child’s eligibility for dependent coverage under this rule is based solely on the child’s age and his or her relationship to the participant. If the child is under age 26 and is the participant’s child, he or she is eligible for dependent coverage. This means that a plan or issuer may not deny or restrict coverage for a child who is under age 26 based on whether the child is financially dependent on the participant, resides with the participant or with any other person, is a student, is employed or any combination of these factors.
The health care reform law also revised the tax code to provide that the coverage under the age 26 rule is tax-free to the employee. However, the tax rules differ slightly from the coverage requirement. Under the tax code, the tax-free coverage is available, effective as of March 30, 2010, to “any child (son, daughter, stepson, stepdaughter, adopted child or eligible foster child of the taxpayer) who as of the end of the taxable year has not attained age 27.” If the child has coverage beyond age 26, that coverage will be tax-free until the end of the tax year.
Because of the broad tax exclusion provided by health care reform, this definition may be the only one a plan may need to review to determine if the coverage is tax-free to the employee’s child. However, there are circumstances where the Code Section 152 definition of dependent may still be necessary. For example, if the dependent is over age 26 and is disabled, or is a grandchild, niece or nephew rather than the employee’s child, coverage can still be provided on a tax-free basis.
Code Section 152 Definition of Dependent
Under the Code Section 152 definition of dependent, an individual must be either a “qualifying child” or a “qualifying relative” to be a dependent, as described in the definitions below. However, as outlined in the next section, there are exceptions to these definitions when it comes to eligibility for tax-free, employer-provided health care. Note that these requirements are more restrictive than the broad definition of dependent added by health care reform.
Qualifying Child – A Qualifying Child must meet all of the following:
- Is the employee’s daughter, son, stepchild, adopted child, eligible foster child, sibling, half-sibling, stepsibling or a descendant of any of these individuals
- Has the same principal abode as the employee for over half the year
- Is younger than the employee, is under age 19 at the end of the year, or if a full-time student, under age 24 at the end of the year, or disabled
- Does not provide more than half of his or her own support
- Is unmarried (see exception below)
An individual may be treated as the qualifying child of a nonparent if no parent claims the individual as a qualifying child and the nonparent has a higher adjusted gross income than any parent.
Qualifying Relative – A Qualifying Relative must meet all of the following:
- Is not a Qualifying Child
- Is a relative of the employee, or has the same principal place of abode as the employee and is a member of the employee’s household
- Has gross income under the personal exemption amount for purposes of computing taxable income ($3,650 for 2010; $3,750 for 2011) (see exception below)
- Receives more than half of his or her support from the employee
Impact on Employer-Provided Health Coverage
Under the definition of dependent added by the health care reform law, health plans may find it easier to determine whether an individual qualifies for tax-free coverage as a dependent. This is because plans will have to confirm only that the individual is the participant’s child who is under age 27 as of the end of the tax year. However, an individual can still qualify as a dependent, and be eligible for tax-free coverage, under Code Section 152.
In using the Code Section 152 dependent definitions, keep in mind that for purposes of determining whether an individual is a dependent eligible for tax-free health benefits, certain portions of the Code Section 152 definition will not apply. Requirements related to married dependents and dependents with children, along with the gross income limitation in the definition of qualifying relative, are not applicable. Specifically, to be a qualifying child, the child can be married, but cannot file a joint return with his or her spouse, unless it is to claim a refund. Also, a qualifying relative can be married and is able to file a joint return with a spouse.
Due to these technical corrections, certain individuals who would otherwise not qualify as dependents under Code Section 152 may still qualify for tax-free health benefits. For example, an employee’s child who does not meet the definition of qualifying child may still be a qualifying relative for health coverage purposes, even if he or she earns more than the gross income limit set out in that definition.
Potential Tax Consequences
Some employers may wish, or be required, to cover individuals not considered dependents under either the Code Section 152 definition or the new definition added by health care reform. For example, some states require employers to cover dependents up to a certain age, beyond age 26. In this case, the plan document or health insurance policy could be drafted to provide for the expanded coverage.
However, coverage for a child who is not a dependent under the tax code will not qualify for exclusion from the employee’s income and cannot be paid for on a pretax basis under a cafeteria plan, even if the dependent is eligible for coverage under the terms of the health plan. Therefore, employers should be aware of potential tax consequences of covering these individuals and should communicate those consequences to employees.