Guest Article

(From the April 18, 2011 issue of Deloitte's Washington Bulletin, a periodic update of legal and regulatory developments relating to Employee Benefits.)

California Retroactively Adopts Income Exclusion for Adult-Child Coverage - 2010 Taxes Are Affected

Signed into law on April 7, California Assembly Bill 36 retroactively adopts for California individual income tax purposes the favorable federal tax treatment provided for adult-child medical coverage under the Health Care and Education Reconciliation Act of 2010 (HCERA). Effective March 30, 2010, the HCERA expanded the income exclusion for reimbursements for medical care expenses under an employer-provided accident or health plan under Code § 105(b) - as well as the deduction for health insurance costs for the self-employed under Code § 162(l)(1) - to include such reimbursements and costs for adult children under age 27, regardless of whether the child is a dependent for federal income tax purposes. California law now applies these changes "in the same manner and to the same periods" as HCERA - so the changes apply to individual state income tax returns and employer wage reporting and withholding for 2010.

PPACA Mandated Adult-Child Coverage Compelled Federal Tax Changes

For plan years beginning on or after September 23, 2010, the Patient Protection and Affordable Care Act (PPACA) requires group health plans (and health insurance issuers) that provide dependent child coverage to make the coverage available to an employee's child until the child reaches age 26. In fact, plan sponsors and insurers were urged to voluntarily provide the adult-child coverage before the PPACA deadline. On the heels of the PPACA, the HCERA was enacted to expand the favorable tax treatment provided for employer-provided medical coverage to include the PPACA-mandated adult-child coverage. Code § 105(b) - which excludes from the employee's gross income employer-provided reimbursements for the medical care of the employee, spouse or dependents - was expanded to also exclude reimbursements for the medical care of an employee's child who has not attained age 27 as of the end of the taxable year. Code § 162(l)(1) - which allows a self-employed individual to deduct the cost of medical insurance for the individual, spouse, and dependents - was expanded to also include the cost of coverage for the individual's child who has not attained age 27. Also, Code § 501(c)(9) - which exempts voluntary employees' beneficiary associations (VEBAs) from tax - was expanded to permit VEBAs to provide sick and accident benefits to a member's child who has not attained age 27

Disparity Between Federal and State Tax Laws

Disparity between the federal and state tax treatment of adult-child health coverage became a reporting and payroll tax concern from the outset. While most states follow the Internal Revenue Code when it comes to defining "wages" and other forms of taxable income, unless the state's revenue code is drafted to automatically conform to changes made in the Internal Revenue Code, state legislative action is needed to maintain the conformity. The period between the enactment of a federal law and the enactment of conforming state legislation can be a confusing one for employers and individual taxpayers.

California Conforming Legislation - 2010 Returns

California Assembly Bill 36 adopts the changes made to Code §§ 105(b), 162(l)(1) and 501(c)(9) and applies them "in the same manner and to the same periods" as HCERA. Going forward, the new California law also excludes from wages - for purposes of state unemployment insurance tax - employer-provided medical benefits and payments for adult children. In terms of how the law impacts employers for 2010, the California Employment Development Department advises:

To amend payroll tax returns, employers are directed to the 2011 California Employer's Guide (DE 44).

For purposes of individual state income tax returns for 2010, the California State Franchise Tax Board advises individual taxpayers whose state wages on Form W-2 included the cost of adult-child coverage to contact the employer and request a corrected form (i.e., Form W-2C) excluding the amount. If a Form W-2C is not issued, the individual is advised to use a California Form FTB 3525 as a substitute. For individuals who already filed a California income tax return (i.e., Form 540), the Board advises that they file an amended return (i.e., Form 540X) to report the reduction in wages or, for self-employed individuals, to exclude health insurance premiums that were paid for nondependent adult children.

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, Erinn Madden 202.220.2692, Bart Massey 202.220.2104, Tom Pevarnik 202.879.5314, Sandra Rolitsky 202.220.2025, Deborah Walker 202.879.4955. Copyright 2011, Deloitte.