Guest Article

(From the August 23, 2010 issue of Deloitte's Washington Bulletin, a periodic update of legal and regulatory developments relating to Employee Benefits.)

Minnesota Department of Revenue Comments on State Tax Nonconformity

When it comes to defining "wages" and other forms of taxable income, most state revenue codes follow the Federal Internal Revenue Code. But what happens when Congress changes one or more of the IRC's relevant provisions? Many states have drafted their revenue codes to automatically conform to these changes. Others, however, require legislative action to conform. In this latter situation, the period between Congressional action and conforming legislation can be a confusing one for employers and individual taxpayers. Recognizing that, the Minnesota Department of Revenue recently stepped in to help employers in that state deal with some nonconformity issues created by the Patient Protection and Affordable Care Act (PPACA) and the Health Care and Education Reconciliation Act (HCEA) until the legislature acts or further guidance is issued.

There are two specific provisions at issue. The first involves the tax treatment of health benefits provided to employees' children who are less than 26 years old but may not be the employee's "dependent" for tax purposes. The second is the exemption for employer provided adoption assistance.

Tax Treatment of Health Benefits for Employees' Children

The value of employer-provided health benefits to employees and their spouses and "dependents" is not treated as taxable income to employees under the IRC. Basically, for this purpose an employee's "dependent" is a relative (e.g., child, parent, etc.) of the employee or otherwise is a member of the employee's household, and for whom the employee provides more than one-half of his or her support. If the employer provides coverage to someone who is not an employee's spouse or "dependent" (e.g., the employee's non-dependent domestic partner), then the value of that coverage is treated as taxable income to the employee.

The HCEA added a new wrinkle to this by specifying that the value of health coverage provided to an employee's child who will be 26 years old or younger as of the end of the taxable year is not included in the employee's income, even if the child is not the employee's "dependent." This change was driven by another PPACA provision that requires employer-provided group health plans that cover dependents to allow employees' children to continue to participate until age 26. Although the PPACA provision is effective for plan years beginning on or after September 23, 2010, the special tax rule for coverage provided to employees' children took effect on March 30, 2010 - the date the HCEA was enacted.

According to the Minnesota Department of Revenue, the Minnesota legislature has not yet enacted legislation to conform the state's revenue code to this change to the IRC - and will not have an opportunity to do so until the legislature reconvenes on January 4, 2011. As a result, it is possible that Minnesota residents will have to recognize as taxable income the value of employer-provided coverage to one or more of their children for state tax purposes but not for federal tax purposes beginning in 2010. Likewise, there are wage reporting and withholding implications for their employers.

A posting to the Minnesota Department of Revenue's Web site provides some relief by specifying that, until the Minnesota legislature has had the opportunity "to fully address" this issue "the Department of Revenue will not require employers to withhold taxes from those federally exempt employer provided benefits." However, because employees might be required to include these "federally exempt employer provided benefits" as income on their 2010 Minnesota income tax returns if the law is not changed, the Department of Revenue also "encourages employers to share this information with affected employees so the employees can decide whether to elect additional withholding if they are concerned about being sufficiently withheld."

Adoption Assistance

The PPACA also increased the maximum allowable Federal income exemption for employer-provided adoption expenses in 2010 from $12,170 to $13,170. Because Minnesota tax law has not yet been updated, Minnesota residents receiving the maximum employer-provided adoption assistance under the IRC will have to include the additional $1,000 in income for state income tax purposes that is not includible for federal income tax purposes. As with employer-provided health benefits for employees' children, the Minnesota Department of Revenue's Web site posting clarifies Minnesota employers are not required "to withhold taxes for these federally exempt employer provided benefits" but notes employers may want to discuss this issue with affected employees so they can decide if they want to elect additional withholding to cover the potential state income tax liabilities.

What About 2011?

The Minnesota Department of Revenue's informal guidance on these topics clearly is intended to help bridge the gap until the Minnesota legislature has an opportunity to take up conforming legislation during its 2011 session. If the legislature fails to act additional guidance from the Department of Revenue likely will be needed.

The information in this Washington Bulletin is general in nature only and not intended to provide advice or guidance for specific situations. If you have any questions or need additional information about articles appearing in this or previous versions of Washington Bulletin, please contact: Robert Davis 202.879.3094, Elizabeth Drigotas 202.879.4985, Mary Jones 202.378.5067, Stephen LaGarde 202.879-5608, Bart Massey 202.220.2104, Tom Pevarnik 202.879.5314, Sandra Rolitsky 202.220.2025, Deborah Walker 202.879.4955. Copyright 2010, Deloitte.