On March 21, 2011, Minnesota amended its state tax law for 2010 to conform it to federal tax law on health benefits provided to a child through the end of the year in which the child attains age 26. While this is welcome relief for 2010, it does not address 2011 or subsequent years and employers in Minnesota continue to face burdens with respect to payroll and reporting income to employees.
Section 1004(d) of the Health Care and Education Reconciliation Act (HCERA) amended section 105(b) of the Internal Revenue Code (Code) to exempt health care benefits provided to a child through the end of the year in which the child attains age 26 from federal income tax. This change, however, caused federal and state tax laws in certain states, such as Minnesota, to diverge. This is because Minnesota is a state where the legislature must act to update the state tax law when there is a change at the federal level. In 2010, Minnesota’s legislature updated the state tax law to conform to the federal tax law as of March 18, 2010, but this date precedes the date on which HCERA was enacted (March 30, 2010) so it did not pick up the tax-favored treatment for coverage of a child through the end of the year in which the child attains age 26. See Minn. Stat. § 289A.02, subd. 7 (2010) (amended by 2010 Minn. Sess Law Chap 216, section 7). Thus, for state tax law purposes, only health benefits provided to a child who is a dependent as defined under section 152 of the Code prior to HCERA (generally requiring satisfaction of a residency or support requirement) are exempt from state income tax.
Minnesota’s Department of Revenue provided some relief to employers in 2010 by stating it did not require employers to withhold state income taxes on health benefits to a child exempt from federal income tax. The Department of Revenue, however, noted that employers had an obligation to properly report such amounts on the employee’s Form W-2. The Department of Revenue’s statement is available here.
Minnesota’s legislature has now amended state tax law to conform it to federal tax law, but only for 2010. See Minn. Stat. § 289A.02, subd. 7 (2011) (amended by 2011 Minn. Sess Law Chap 8, section 1). The statute also provides that employers do not need to re-issue Form W-2 to an employee if the employer included the amount of health benefits as income for state tax purposes on the employee’s Form W-2. (Our understanding is that the Department of Revenue intends to try to identify these returns, adjust the state tax due, and issue a refund.) Although not addressed in the statute, nothing indicates employers need to provide notice to employees of this retroactive change in state tax law.
2011 and Beyond
Minnesota’s legislature did not amend Minnesota state tax law for 2011 or subsequent years. This creates a difficult situation for employers in Minnesota because as of January 1, 2011, calendar year employer group health plans generally were required under health care reform to cover a child through the date the child attains age 26. Minnesota’s Department of Revenue has indicated that while the legislature is reviewing whether to conform state tax law for 2011, employers do not need to withhold state income taxes on federally exempt employer provided health care benefits (continuing the guidance noted above). If, however, an employer issues a Form W-2, then the employer must include in state income the amount of health benefits provided to a child through the end of the year in which the child attains age 26 (unless the child was a dependent as defined under section 152 of the Code before HCERA). The uncertainty over whether the legislature will act imposes a burden on employers and payroll administrators.
To simplify burdens on employers, ideally the Minnesota legislature will act to conform Minnesota state tax law to federal tax law for 2011 and subsequent years. The legislature, however, is already more than one half way through the legislative session, which is scheduled to adjourn on May 23, 2011 and will not reconvene (outside of a special session) until February 2012 or later (the date has not yet been set). Employers interested in this issue should contact their representatives. If you wish to discuss this, please contact the attorney in the Benefits and Compensation practice group with whom you work.