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The Patient Protection and Affordable Care Act and the Health Care and Education Reconciliation Act (Healthcare Reform Act) extended certain rights and tax exclusions for expenses paid by taxpayers for their adult children. Group health plans and health insurance issuers must offer dependent coverage for an adult child up to age 26. The Healthcare Reform Act also provides favorable tax treatment for employer-provided healthcare coverage or medical expense reimbursements for employee’s adult children. Unfortunately, the definition of an adult child differs from one section to another.

Internal Revenue Service (IRS) Notice 2010-38 refines and amplifies the language of the Healthcare Reform Act, and answers a multitude of questions pertaining to effective dates, IRS Code Section changes, plans affected and plan amendments. The Notice contains welcome details for sponsors of cafeteria plans, flexible spending accounts (FSAs), health reimbursement arrangements (HRAs), voluntary employees’ beneficiary associations (VEBAs), certain retiree health accounts in pension plans, and deductions by self-employed individuals for medical care insurance.

What is the definition of an Adult Child?

The definition is quite simple:

An "Adult Child" is an employee’s child (as defined in IRC Section 152(f)(1)) who has not attained age 27 as of the end of the employee’s taxable year. An employee’s taxable year is generally January 1 through December 31.

IRC Section 152(f)(1) is literally the definition of a child. It means an individual who is a son, daughter, stepson, or stepdaughter of the taxpayer, or an eligible foster child. It also includes an adopted child (a legally adopted individual or an individual who is lawfully placed with the taxpayer for legal adoption.) An eligible foster child would be considered a taxpayer’s child if they were placed with the taxpayer by an authorized placement agency or by judgment, decree, or other order of any court of competent jurisdiction.

The IRS definition of a qualifying child which includes a different age limit, residency and support requirements does not apply to this definition of an Adult Child.

The IRS Code Section 152 definition of a dependent has not been amended or changed, rather the definition of an Adult Child has been, or will be, inserted into different Sections of the IRS Code.

What is the effective date of coverage for an Adult Child?

The definition takes effect retroactively to March 30, 2010. Any amendments to IRS Code Sections that have not been published will be retroactive to March 30, 2010. The Healthcare Reform Act requires plans that cover dependent children to provide for coverage of children until age 26 beginning with the plan year starting on or after September 23, 2010. There is no requirement to cover children of covered dependent children, and the requirement is applicable even if the child is married or is not a tax dependent. Until January 1, 2014, grandfathered plans do not have to extend coverage if the child is eligible for other employer coverage. While extending this coverage is required beginning with the plan year starting on or after September 23, 2010, the Department of Health and Human Services (DHHS) is encouraging coverage be extended as soon as possible.

Cafeteria Plans, Flexible Spending Arrangements, and Health Reimbursement Arrangements

The exclusion from gross income for expenses paid for health insurance coverage and reimbursements of medical expenses under IRS Code Sections 106 and 105(b) for an employee’s Adult Child carries forward automatically to the definition of qualified benefits for cafeteria plans, including health FSAs.

IRS Regulation 1.125-4, which stipulates permitted election changes for a cafeteria plan, will be retroactively amended to include change in status events affecting nondependent children under age 27, including becoming newly eligible for coverage or eligible for coverage beyond the date on which the child otherwise would have lost coverage.

The same rules apply for health reimbursement arrangements.

Transition Rule for Cafeteria Plan Amendments

Although amendments to cafeteria plans may only be effective prospectively, in this case, employers may permit employees to immediately make pre-tax salary reduction contributions for accident or health benefits under a cafeteria plan (including a health FSA) for children under age 27, even if the cafeteria plan has not been amended to cover these individuals. However, a retroactive amendment for this purpose must be made no later than December 31, 2010 and must be effective retroactively for any date on or after March 30, 2010.

FICA, FUTA, RRTA and Income Tax Withholdings

For tax purposes, coverage and reimbursements paid by the taxpayer for their Adult Children are excluded from wages for Federal Insurance Contribution Act (FICA), Federal Unemployment Tax Act (FUTA) and the Railroad Retirement Tax Act (RRTA).

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The information contained in this article is not intended to be legal, accounting or other professional advice. We assume no liability whatsoever in connection with its use, nor are these comments directed to specific situations.