Taxability of dependent medical care

[Guest RichardParker]

I manage 5 medical plans in 3 states. They vary in their descriptions of what constitutes and eligible dependent. Some go to 25, some don't need student status, etc. The IRS is pretty clear in Publication 501 that to be a qualified dependent for tax purposes, you must be under 24, provide no more than half your support, be a full-time student and live at home. What if a carrier extends dependent coverage to a 23 year old who is not in school? What about a 21 year old who lives by herself, has a full-time job and goes to school nights? Would these be a taxable benefit to the parents?

Thanks for any wisdom.

Parker

[J Simmons]

Yes, the value of the coverage provided to a 'dependent' that does not meet the WFTRA-revised tax definition should be included in the taxable income reported to the employee, even though the coverage for that 'dependent' is required under state law.

[MARYMM]

I manage 5 medical plans in 3 states. They vary in their descriptions of what constitutes and eligible dependent. Some go to 25, some don't need student status, etc. The IRS is pretty clear in Publication 501 that to be a qualified dependent for tax purposes, you must be under 24, provide no more than half your support, be a full-time student and live at home. What if a carrier extends dependent coverage to a 23 year old who is not in school? What about a 21 year old who lives by herself, has a full-time job and goes to school nights? Would these be a taxable benefit to the parents?

Thanks for any wisdom.

Parker

How do you determine the amount of the taxable benefit ? Say an employee has a spouse and 2 dependent children (who qualify under IRS guidelines) in addition to the 21 year old in your example ? The premium charged to the employer is the same whether or not the overage child is covered.

A quick look at what NJ did seems to show that they carved out coverage for the overage dependent and assigned a cost to it - a % of the single premium amount. Unfortunately I don't see where CT has done that in the legislation that is effective 1/1/09

Also, I'm assuming that if there is a premium difference (overage child causes coverage to change from single to 2 person) that additional cost can't be paid pretax thru a Sec 125 Plan.

[J Simmons]

How do you determine the amount of the taxable benefit? Good question.

Clearly the delta between what the premium would have been without the ineligible dependent and with would be taxable (and yes, not electable through a cafeteria plan on a tax-free basis).

There was a thread last spring I believe (sorry I don't have it linked here) that discussed whether that delta alone would be the value to be included in the EE's taxable income. On the one hand, the premium without the ineligible dependent is tax-free, so the taxable part ought to be just the delta.

On the other hand, maybe it is the value of the coverage (sort of on a stand-alone or more evenly partitioned basis of the entire premium for the 'family' grouping) that ought to be included in taxable income to the EE.

[MARYMM]

How do you determine the amount of the taxable benefit? Good question.

Clearly the delta between what the premium would have been without the ineligible dependent and with would be taxable (and yes, not electable through a cafeteria plan on a tax-free basis).

There was a thread last spring I believe (sorry I don't have it linked here) that discussed whether that delta alone would be the value to be included in the EE's taxable income. On the one hand, the premium without the ineligible dependent is tax-free, so the taxable part ought to be just the delta.

On the other hand, maybe it is the value of the coverage (sort of on a stand-alone or more evenly partitioned basis of the entire premium for the 'family' grouping) that ought to be included in taxable income to the EE.

I've been googling a bit more and found some info on the MN and MA state websites. Their laws were effective this year, so they've done the legwork already.

Here

http://www.co.hennepin.mn.us/portal/site/H...0000f094689RCRD

and here

http://www.mass.gov/gic/dependent19qanda.html#imputed

They are using FMV of the coverage, i.e. the employer's actual premium for single coverage, to determine the imputed income. (An employer I contacted in MN is using the COBRA cost - not sure how they arrived at that yet.)

That makes sense. If the ee has an increased contribution for the dependent, it would be after-tax and the imputed income would be the single coverage cost. If there is no increased contribution (already has family coverage), then it is the same imputed income, but no additional premium deduction.

[Guest Sieve]

If the child were a "qualifying relative" under Section 152, which has no age limit (if the child is not also a qualifying child for dependent purposes), wouldn't the premiums still be excluded from the employee's income?

If it happens that the individual is neither a qualifying child nor a qualifying dependent, then wouldn't reimbursements for medical expenses from the employee's health plan also be included in income (a potentially huge number) since the payments are to reimburse an employee for the medical expenses of a non-dependent? (IRC Section 105(b).) (If the individual has his/her own coverage, then reimbursements will not be inlcuded in income (IRC Section 104(a).)

[J Simmons]

If the child were a "qualifying relative" under Section 152, which has no age limit (if the child is not also a qualifying child for dependent purposes), wouldn't the premiums still be excluded from the employee's income?

YES

If it happens that the individual is neither a qualifying child nor a qualifying dependent, then wouldn't reimbursements for medical expenses from the employee's health plan also be included in income (a potentially huge number) since the payments are to reimburse an employee for the medical expenses of a non-dependent? (IRC Section 105(b).) (If the individual has his/her own coverage, then reimbursements will not be inlcuded in income (IRC Section 104(a).)

Would the individual have his/her own coverage if the premiums were taxed to the employee? and thus 104(a) apply instead of needing 105(b)?

Probably a stickier question in the self-funded context.

[Guest Sieve]

(Are we playing the game on "Whose Line Is It, Anyway?" where every sentence must be a question? Or aren't we? )

At first blush, I thought it would be covered under 105(b). But I like your very simple and to-the-point argument, and can accept 104(a). On audit, however, could the IRS, perhaps, argue to exclude the income and include reimbursements? Which do you think comes first, the chicken or the egg?

[J Simmons]

For consistency sake, would the IRS argument to exclude the premium have to concede that the person in question in an eligible dependent, and therefore defeat their attempt to include the covered health expenses as beyond 105(b)?

[Guest Sieve]

Sorry, I can't put this in the form of a question, so let's look at it this way . . .

I think the answer to your question is No. The IRS argument, for what it's worth, would go something like this:

• We use IRC Section 105 for non-contributory (or partially contributory) plans rather than IRC Section 104(a)(3). (Treas. Reg. Section 1.105-1(a): "In determining the extent to which amounts received . . . by an employee through an accident or health plan are subject to the provisions of section 105(a), rather than section 104(a)(3), the provisions of paragraphs (b), ©, (d), and (e) of this section shall apply." And then, see appropriate follow-up in Treas. Reg. Section 1.105-1.)
  
• IRC Section 105 applies because, whether or not any portion of the premium amount is includible in the employee's income, the employer is paying the premiums (IRC Section 105(a)(2)).
  
• Whether or not we know or can determine what amount/portion of the premium should have been included in the employee's income, that doesn't matter because of 105(a) (which requires that reimbursements be included in the employee's income to the extent they are provided by the employer (Treas. Reg. Section 1.105-1)).
  
• Moving to the exclusion/exemption of IRC Section 105(b), notice that the exclusion from income does not apply to the extent that the reimbursements are for medical expenses of a non-qualifying child/dependent. Therefore, all of the reimbursement amounts for medical expenses of the non-dependent should be included in income under the general rule of IRC Section 105(a), no matter how much of the premium is paid by (or includable in the income of) the employee.
  
• And, oh, by the way, we still want to determine the amount that should be included in the employee's income representing the portion of the premium cost related to non-dependents under IRC Section 106. And don't forget that including those premium amounts in income still does not get the employee out from under the general income includability rule of IRC Section 105(a) relating to reimbursements from the health plan (as per Treas. Reg. Section 105-1 and IRC Section 105(a)), but might reduce the portion of the reimbursement that is included in income (as per the regs - e.g., see 1.105-1(d), ex.). (But I wonder if the 1.105-1 regs--re: a portion of the premium provided by the employer--really are applicable here, since (i) the cost is not "borne" by the employee just because some portion of the premium is included in income, and (ii) there is a non-dependent beneficiary of the policy who is getting reimbursements, contrary to the exclusion of IRC Section 105(b).)
  

Don't know how smooth this argument is (the IRS would do a better job), but I think that IRC Section 105 puts at least a portion--if not all--of the reimbursement for medical expenses of the non-dependent on the table as includable income. But, seems like this argument would work. After all, you never leave IRC Section 105 or migrate over to Section 104.