Recent Changes in Health Insurance Coverage for Dependents

Jim D. Brandenburg, CPA, MST, Shareholder - Tax   email | bio
Joy J. Duce, SPHR, Director of Human Resources   email | bio
March 2010

There have been recent changes at both the federal and Wisconsin levels regarding health insurance coverage for dependents. The new laws effect how health insurance is applied to college students, as well as covered dependents over age 17 and under age 27.

Michelle's Law - Federal and Wisconsin Change

Michelle Morse, a New Hampshire college student who contracted colon cancer, was unable to reduce her college course load while she struggled with the disease, because if she did, she would lose her health insurance. In 2005, Michelle lost her battle with cancer. Following Michelle's death her mother, Ann Marie, with the help of legislators and a number of medical and professional organizations, was able to get New Hampshire to become the first state to pass Michelle's Law. Michelle's Law allows college students that fall seriously ill to continue to receive health care through their family's insurance policy, even if they are unable to maintain full-time student status. In October 2008, President Bush signed into law a federal version of Michelle's Law, which became effective October 9, 2009. This new law provides that to be eligible for coverage, a dependent child must:

1. be enrolled in their parent's health insurance plan as a student immediately before the first day of medical leave; and

2. provide medical certification of their health condition.

Once the student is determined eligible, the student's health insurance plan must continue coverage for one year beginning the first day of a medical leave of absence from school.

Up to Age 27 Coverage for Dependents - Wisconsin Change

In 2009, Wisconsin enacted new legislation that requires health insurers to provide health insurance coverage for an adult child of the insured. This new law is effective for health insurance policies issued or renewed on or after January 1, 2010. In order to be eligible, a dependent child must satisfy all of the following requirements:

• the child is over 17, but less than 27 years of age;
• the child is not married; and
• the child is not eligible for coverage under a group health benefit plan that is offered by the child's employer and for which the amount of the child's premium contribution is no greater than the premium amount for his/her coverage as a dependent under the parent's plan.

Companies are required by this new Wisconsin law to extend dependent health insurance coverage to individuals who may not qualify as dependents of the employee for tax purposes (referred to as a non-tax dependent). Under federal tax law, the value of employee health insurance paid for by an employer, including coverage for spouses and dependents for tax purposes, is a tax-free fringe benefit that is excluded from the employee's gross income. Therefore, employer-provided health insurance for an adult child of an employee is only excluded from the employee's gross income if the adult child qualifies under federal tax law as a dependent of the employee.

In order to qualify as a dependent on a parent's federal income tax return, the child must be treated as either a qualifying child or a qualifying relative. Please click here for the definitions of both terms as spelled out by Internal Revenue Service(IRS) Publication 501. (Note: The gross income requirement of the child for the qualifying relative test does not apply for purposes of determining whether the health insurance coverage is taxable.)

If the adult child does not qualify as a dependent, the employee is treated as receiving additional taxable income for income tax, Social Security tax and Medicare tax purposes. The amount of additional income is measured by the excess of the fair market value of the adult child's health insurance coverage less the parent's additional out-of-pocket cost for this coverage. The fair market value of the adult child's health coverage is determined by the employer or their insurance provider; it is not determined by the IRS. Further, the additional health insurance costs for a non-tax dependent cannot be paid through a Section 125 plan (cafeteria plan). Costs must be paid on an after-tax basis by the employee.

Example: Barry works for Randall Company. His family health insurance coverage includes his wife Becky. Barry pays $400 a month for coverage which is paid on a pre-tax basis through Randall Company's cafeteria plan. As a result of Wisconsin's new law, Barry is now able to include his son Bucky, age 25, who is working on his own with no health insurance. Barry learns that the added out-of-pocket cost of dependent coverage for Bucky is $150 per month. His employer also informs him that the fair market value of Bucky's health insurance plan is $8,000.

Results: Barry reads through IRS Publication 501 and determines that Bucky is not a qualifying child, nor is he a qualifying relative. Thus, Bucky does not qualify as a dependent for tax purposes. Barry is therefore treated as receiving $6,200 additional income for 2010 income tax and payroll tax purposes ($8,000 fair value of health insurance coverage for Bucky, less the $150 per month that Barry pays for Bucky's coverage). In addition, Barry cannot pay the additional $150 per month out of his cafeteria plan at Randall Company. It must all be paid on an after-tax basis.

It is generally not the responsibility of the employer to determine whether the children of its employees qualify as dependents for tax purposes. It is the role of the employee to make that determination and inform the employer. If the employee indicates that their child, now covered under the company's health insurance plan, is a non-tax dependent it is then the responsibility of the employer to determine a fair market value for the dependent's coverage. The fair market value (less the amount the employee paid) would be used by the employer to determine how much income to include in the employee's Form W-2 for the year.

Employers and employees should be aware of these recent changes and their implications. Your health insurance provider can provide the specific application of these new rules to your health insurance plan.