With a first round of Health Reform law clarification, the IRS is permitting employers to choose to provide "gap" coverage for adult children between now and the time such coverage is mandated for their health plans. The tax treatment, also, is now clear.

The Patient Protection and Affordable Care Act (as modified by the Health Care Reconciliation Act of 2010) made two changes that were not completely parallel:

(1) effective as of March 30, 2010, the definition of "dependent" was expanded to include the adult child who has not attained age 27 by the end of the taxable year; and

(2) effective for the first plan year after September 23, 2010 (January 1, 2011 for calendar year plans), group health plans must cover adult children under age 26, with some limitations for "grandfathered" plans.

The IRS has issued Notice 2010-38 which allows, but does not require, such coverage in 2010 for an adult child who does not attain age 27 by the end of the calendar year. Adult children may be covered in the same manner as a dependent child for purposes of

  • not taxing the group medical benefits provided, and
  • permitting the employee to pay for the coverage on a pre-tax basis under the employer's Section 125 plan.  

To do this, the IRS announced that it intends to amend its regulations under Code Section 106 and Section 125. These amendments will permit, retroactively to March 30, 2010, the change in status rules affecting non-dependent children who do not attain age 27 in the calendar year to allow them to be added to coverage beyond the date they otherwise would have lost coverage. If these changes are made in 2010, employers must amend their Section 125 plans no later than December 31, 2010.

Thus, while coverage until age 26 will be required by the new law, these clarifications from the IRS will permit employers to continue such coverage through the end of the calendar year in which adult children turn 26 and to provide coverage prior to the effective date of the mandatory coverage rule.

Employers should review their group medical plans, including HRAs and FSAs, to determine whether to extend coverage to non-dependent adult children, how to provide any retroactive coverage, what to communicate to employees, and where to amend their plans. Such changes could extend coverage to college students graduating or leaving school this spring and adult children who are not dependent or even living apart from the employee-parent. Pricing for such extended coverage should be considered and, if increased, should be reviewed under the Section 125 rules for passing along added costs mid-year.