As has been widely reported, the Patient Protection and Affordable Care Act and the Health Care and Education Reconciliation Act (collectively, “Health Care Reform”) require group health plans that provide dependent coverage for children to continue such coverage until the child reaches age 26 and also excludes such coverage from the employee’s taxable income. Recently, the Internal Revenue Service (“IRS”) interpreted this coverage requirement in interim final regulations issued in conjunction with the Departments of Labor and Health and Human Services which clarify the scope and applicability of such coverage requirement and in IRS Notice 2010-38 which provides guid-ance on the related tax changes.

New Age 26 Coverage Regulations  

The Regulations provide that a plan that makes dependent coverage available for children must continue such coverage until attainment of age 26. Under the Regulations, conditioning coverage on whether a child is a tax dependent, a student, or resides with or receives financial support from a parent is no longer permissible. Accordingly, a plan may not define dependent for purposes of eligibility for dependent coverage of children other than in terms of the relationship between the child and the partici-pant. Examples of factors that may not be used for defining dependent for purposes of eligibility include financial dependency on a plan partici-pant, residency with a participant, student status, employment, eligibility for other coverage, or any combination of these factors. However, there is an exception to the preceding rule for “grandfathered plans” which until January 1, 2014, may exclude an adult child who has not attained age 26 from coverage if the child is eligible to enroll in an employer-sponsored health plan other than a group health plan of a parent.  

The Regulations also provide that the terms of a plan relating to dependent coverage may not vary based on the age of a child, except for children age 26 or older. In addition, for children under age 26, the plan may not vary benefits based on the age of the child. However, neither Health Care Reform nor the Regulations require a group health plan to provide coverage to the spouse or child of an eligible child.  

The Regulations require that a group health plan provide all eligible children with an opportunity to enroll in plan coverage that continues for at least 30 days (including written notice of the opportunity to enroll) regardless of whether the plan offers an open enrollment period and regardless of when any open enrollment period might otherwise occur. This enrollment opportunity (including the written notice) must be provided no later than the first day of the plan year beginning on or after September 23, 2010 (January 1, 2011 for calendar year plans). Therefore, many plans will be able to use their existing annual enrollment period (which commonly begin and end before the start of the plan year) to satisfy the enroll-ment opportunity requirement.  

The required enrollment notice may be provided to an employee on behalf of the employee’s eligible child. In addition, the notice may be included with other enroll-ment materials that a plan distributes to employees, provided the statement is provided in a prominent manner.  

Any child enrolling in group health plan coverage pursuant to this new enrollment right must be treated as a special enrollee, as provided under the Health Insurance Portability and Accountability Act of 1996 (“HIPAA”) portability regulations. Therefore, the child must be offered all the benefit packages available to similarly situated individuals and cannot be required to pay more for coverage than similarly situated individu-als. For example, if a child qualifies for this new enrollment opportunity and the parent is not enrolled but is otherwise eligible for enrollment, the plan must provide an opportunity to enroll the parent, in addition to the child.  

Tax Treatment of Adult Children Health Benefits

As indicated above, Health Care Reform amended the Internal Revenue Code to give certain favorable tax treatment to health benefits provided to adult children. Specifically, Health Care Reform amended Code Section 105(b), effective March 30, 2010, to extend the general exclusion from gross income for reimbursements for medical care under an employer-provided accident or health plan to any employee’s child who has not attained age 27 as of the end of the taxable year. According to Notice 2010-38, for purposes of this exclusion, a child is an individual who is the son, daughter, stepson, or stepdaughter of the employee and a child includes both a legally adopted individual of the employee, an individual who is lawfully placed with the employee for legal adoption by the employee and certain foster children. In addition, the age 27 exclusion applies with respect to a child of the employee who is not the employee’s dependent within the meaning of Code Section 152(a).  

Code Section 106 excludes from an employee’s gross income coverage under an employer-provided accident or health plan. The regulations under Code Section 106 provide that the exclusion applies to employer-provided coverage for an employee and the employee’s spouse or dependents. Prior to Health Care Reform, the exclusion for employer-provided accident or health plan coverage under Section 106 paralleled the exclusion for reim-bursements under Section 105(b). According to Notice 2010-38, there is no indication that Congress intended to provide a broader exclusion in Section 105(b) than in Section 106. Therefore, the IRS intends to amend the regulations under Section 106, retroactively to March 30, 2010, to provide that coverage for an employee’s child under age 27 is excluded from the employee’s gross income.  

Also, Notice 2010-38 provides that coverage and reimbursements for adult children will not be consid-ered wages under the Federal Insurance Contributions Act (“FICA”) or Federal Unemployment Tax Act (“FUTA”). In addition, the tax benefits described above and the expansion of coverage to adult children under the age of 27 is applicable to Code Section 401(h) retiree health accounts, Code Section 501(c)(9) volun-tary employees’ beneficiary associations (“VEBAs”) and the deduction by self-employed individuals for medical care insurance under Code Section 162(l).  

The exclusion of coverage and reimbursements from an employee’s gross income under Code Section 105(b) and 106 for an employee’s child who has not attained age 27 will constitute “qualified benefits” for purposes of the rules under Code Section 125 applicable to cafeteria plans and health flexible spending arrange-ments. The current cafeteria plan regulations permit an employee to revoke an election during a period of coverage and to make a new election only in limited circumstances such as a “change-in-status.” A “change-in-status” includes changes in the number of an employee’s dependents but does not permit election changes for children under age 27 who are not the employee’s dependents. According to Notice 2010-38 the IRS plans to retroactively amend the cafeteria plan regulations, effective March 30, 2010, to permit nondependent children under the age of 27 and those children who otherwise would have lost coverage under these plans to be added by employees as covered dependents without causing these plans to become non-compliant with the cafeteria plan regulations.

Transition Rule for Cafeteria Plan Amendments

Employers who intend to amend their cafeteria plans and flexible spending accounts to permit coverage for adult children under the age 27, may permit their employees to immediately make pre-tax salary reduc-tion contributions for accident and health benefits, even if these plans have not yet been amended to reflect the change in coverage option. However, employers must make all retroactive amendments no later than December 31, 2010.