Dependent Coverage

Happy familyThe Patient Protection and Affordable Care Act (PPACA) requires group health plans offering dependent coverage to extend such coverage until dependents reach age 26. The provision was effective for plan years beginning on or after Sept. 23, 2010. If the plan is grandfathered, the provision only applies if the adult dependent does not have other employer-sponsored coverage. After Jan. 1, 2014, the adult dependent must be offered coverage regardless of access to other employer-sponsored coverage.

Interim Final Rules

On May 10, 2010, interim final rules on the dependent to age 26 requirement were jointly issued by the U.S. Departments of Health and Human Services (HHS) and Labor (DOL), as well as the Internal Revenue Service (IRS). The rules require that factors other than the child/participant relationship may not be used for purposes of determining extended eligibility (e.g., financial dependency, residency, student status, marital status). The interim final rules also provide that cost-sharing amounts and benefits for dependent coverage cannot vary based on the age of the child, except for children age 26 or older. Additionally, in the case of an adult dependent who is eligible for coverage under the plans of the employers of both parents, neither plan may exclude the adult dependent from coverage based on the fact that the adult dependent is eligible for other employer-sponsored coverage. This last provision is applicable to grandfathered plans.

Importantly, the rules clarified that although the requirement to provide dependent coverage applies only until the 26th birthday, if coverage extends beyond that date, the value of the coverage may be excluded from the employee’s income for the full tax year (generally the calendar year) in which the child turns 26.

Special Enrollment Opportunity

The interim final rules established a requirement that a plan or issuer must give an adult dependent an opportunity to enroll for at least 30 days, regardless of whether the plan offers an open enrollment period. Any adult dependent enrolling in group health plan coverage must also be treated as a special enrollee under HIPAA. Accordingly, the adult dependent must be offered all the benefit packages available to similarly situated individuals who did not lose coverage (or were denied coverage) based on cessation of dependent status.

Favorable Tax Treatment

On April 27, 2010, the IRS issued IRS Notice 2010-38 on the favorable tax treatment for coverage of adult dependents. Generally, coverage of non-tax dependents equates to taxable income to the employee. PPACA eliminates the tax burden for coverage of adult dependents, even if the child is not a tax dependent. PPACA did not change the definition of tax dependent, but amended Section 105(b) of the Internal Revenue Code (IRC), which provides an exclusion for amounts reimbursed for medical expenses relating to the employee, their spouse and their tax dependents. Section 105 generally applies to self-funded plans. Section 106, which was not amended by PPACA due to oversight, applies to fully insured plans. The notice clarifies that the tax-favored status of adult dependent coverage applies to Section 105 and Section 106 of the IRC.

The non-taxability of adult child coverage was made effective retroactive to March 30, 2010. While PPACA only requires plans to cover adult children until age 26, the tax-favored status applies through the calendar year in which the adult child attains age 26. The retroactive date is important for employers offering fully insured coverage in one of the states that requires coverage of older dependents. The employers in those states may now treat adult dependent coverage as tax-free for purposes of federal income tax in accordance with the guidelines outlined in Notice 2010-38.

The notice also clarifies that the IRS and the U.S. Department of the Treasury will amend the regulations applicable to cafeteria plans to permit employees to change their elections midyear and add coverage for adult children when the child becomes eligible for coverage due to PPACA. The employers that choose to allow midyear elections must amend their plan documents, but the plan has until Dec. 31, 2010, to make the plan amendment. The plan amendment should be retroactive to the first date that the employer allowed an employee to make a midyear election change.

The notice also clarified that the IRS and Treasury also intended to amend the cafeteria plan regulations to clarify that expenses for adult children may be reimbursed tax-free from a health flexible spending arrangement or health reimbursement account. The tax-free status was not extended to health savings account reimbursements for adult children.

Finally, the notice clarified that adult child coverage may be provided through a plan that is funded by a VEBA (voluntary employees’ beneficiary association) or through a Section 401(h) Retiree Medical Account, and the deduction for premium payments made by self-employed individuals includes amounts expended for adult children. The tax-free nature extends to FICA, FUTA and Railroad Retirement Tax.

Employer Action Required

Employers offering dependent coverage must make such coverage available to dependents up to age 26. They must also have amended their cafeteria plan documents no later than Dec. 31, 2010, to reflect the tax implications of offering such coverage. Finally, they must not take into account any other factor, such as residency, marital status, or financial dependency, for determining eligibility under the plan.

Penalties for Noncompliance

If a violation is discovered and is not corrected within 30 days of discovery, then the employer must self-report the violation on IRS Form 8928, and a civil penalty of $100 per day would be assessed. The tax increases to $200 per day if there is more than one qualified beneficiary affected in the same family to whom the failure relates.

There is an exception to this penalty if the plan sponsor can prove that the failure was due to reasonable cause (they did not know and, in exercising reasonable diligence, would not have known) and not due to willful neglect, and the failure was corrected within 30 days. However, if the employer becomes aware of a failure, and makes no effort to correct it, then there is no cap on the amount of excise tax that the IRS could assess.

Frequently Asked Questions

Q1. What plans are required to extend dependent coverage up to age 26?
A. The Affordable Care Act requires plans and issuers that offer dependent coverage to make the coverage available until a child reaches the age of 26. Both married and unmarried children qualify for this coverage. This rule applies to all plans in the individual market and to new employer plans. It also applies to existing employer plans unless the adult child has another offer of employer-based coverage (such as through his or her job). Beginning in 2014, children up to age 26 can stay on their parents’ employer plan even if they have another offer of coverage through an employer.

Q2. Will young adults have to pay more for coverage or accept a different benefit package?
A. Any qualified individual must be offered all of the benefit packages available to children who did not lose coverage because of loss of dependent status. The qualified young adult cannot be required to pay more for coverage than similarly situated individuals who did not lose coverage due to the loss of dependent status.

Q3. Can plans or issuers who offer dependent coverage continue to impose limits on who qualifies based upon financial dependency, marital status, enrollment in school, residency or other factors?
A. No. Plans and issuers that offer dependent coverage must provide coverage until a child reaches the age of 26. There is one exception for group plans in existence on March 23, 2010. Those group plans may exclude adult children who are eligible to enroll in an employer-sponsored health plan, unless it is the group health plan of their parent. This exception is no longer applicable for plan years beginning on or after Jan. 1, 2014.

Q4. What happens if a young adult under the age of 26 is not eligible for employer-sponsored insurance and both parents have separate plans that offer dependent coverage?
A. Neither parent’s plan can deny coverage.

Q5. Does the law apply to plans or issuers that do not provide dependent coverage?
A. Currently, no, but only if the plan is redesigned so that there is no dependent coverage for children. There is no federal requirement compelling a plan or issuer to offer dependent coverage at this time. But, if a plan does offer coverage for dependents, coverage must be made available until age 26. However, under health care reform, applicable large employers will be subject to a “play or pay penalty tax” beginning in 2014, if it fails to offer the opportunity to enroll in “minimum essential coverage” under an eligible employer-sponsored plan to its full-time employees and their dependents.

Additional Resources

Citations

  • PHSA § 2714
  • IRS Notice 2010-38
  • Interim Final Rules Relating to Dependent Coverage of Children to Age 26 Under PPACA
  • 26 CFR Parts 54 and 602; 29 CFR Part 2590; 45 CFR Parts 144, 146, and 147, 75 Fed. Reg. 27121 (May 13, 2010)