The IRS has published notice 2010-38, providing guidance as to the application of the new rules permitting favorable tax treatment of health benefits provided to children of covered employees.  The Patient Protection and Affordable Care Act, as amended by the Health Care and Education Reconciliation Act of 2010, signed into law on March 23 and 30, 2010 (the "PPACA") requires that group health plans and health insurance issuers provide coverage for children of covered until the child reaches age 26.  The coverage requirement of the PPACA is effective for the first plan year beginning on or after September 23, 2010, but the new law effectively permits plans and issuers to provide coverage under the new rules, by providing for favorable tax treatment of coverage and health reimbursements for children under age 27, effective as of March 30, 2010.

Under the PPACA coverage rules, "child" means a child as defined in Internal Revenue Code § 152(f)(1), that is, the natural, stepchild or adopted child of the individual, including an "eligible foster child" or a child placed with the employee for adoption.  The additional requirements of "dependent" for tax purposes no longer apply for purposes of coverage of a child.  Therefore, the child may be married, may be employed, may be eligible for other health coverage (but may not be actually covered), need not live with or be supported by the employee, and need not be a full-time student or disabled.

The IRS guidance states that the IRS and Treasury Department will amend the applicable regulations to permit group health plans and issuers to provide coverage to children of covered employees under the new rules effective as of March 30, 2010, and that such covered children may receive favorable tax treatment for the coverage under Code § 105(b) and for healthcare reimbursements received under the plan under Code § 106.

According to the IRS guidance, appropriate changes in Code § 125 Cafeteria Plan elections, including health FSA elections, will be deemed to be a "status change" under the Section 125 regulations pursuant to changes that will be made to those regulations effective retroactive to March 30, 2010.  Thus, employees who elect under amended plans or polices to cover children under age 27 may also make appropriate changes to their Section 125 plan or health FSA elections.  The guidance provides that these provisions may be implemented immediately, but in that case, the appropriate plan amendments to facilitate such election changes must be adopted no later than December 31, 2010.

Parallel guidance was also provided with respect to Voluntary Employees’ Beneficiary Associations (VEBAs), retiree medical accounts under Code § 401(h) and deductions for health premiums for self-employed individuals under Code § 162(l).

Note that the new rules in effect as of March 30, 2010 permit, rather than require, the affected plans and issuers to cover children that have not reached age 27 by the end of the taxable year, without regard to the otherwise applicable "dependency" rules, so long as the appropriate amendments are made no later than December 31, 2010.  However, effective for plan years beginning on and after September 23, 2010 (for calendar year plans, January 1, 2011) all group health plans and issuers must provide parents with the option to cover children until age 26, as provided in the PPACA.

Russell D. Chapman and Andrea Jackson co-authored this entry.