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Focus on State & Local Taxation: Health Care Costs for Children Under Age 27 May Be Subject to State Taxation

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It may come as a surprise to employers, but many states are not conforming with the new healthcare reform legislation, which requires insurers that provide group health coverage for dependent children to continue such coverage until the dependent turns 26 years old.
February 9, 2011

It may come as a surprise to employers, but many states are not conforming with the new healthcare reform legislation, which requires insurers that provide group health coverage for dependent children to continue such coverage until the dependent turns 26 years old.

As a result, the portion of the premium paid by the employer for medical insurance for the child will be state taxable income to the employee (and not deductible by a taxpayer who is self-employed). Why has all this happened? It takes a little technical explanation.

In order to continue the same federal tax treatment that applies currently to children as defined by (IRC §152(f)(1)), covered as dependents, the healthcare reform bill provides that a child who is under the age of 27 will be considered a dependent of a taxpayer for purposes of the general exclusion for reimbursements for medical care expenses under an employer-provided accident or health plan, the self-employed health insurance deduction, and certain other plans (IRC §105(b)).

As a result of the above change, it is no longer necessary for the child of the employee to be a dependent of the employee in order for this exclusion to apply. Thus, if the child is age 26 or less at the end of the tax year, the exclusion applies even if the child provides more than one-half of his or her own support, earns more income than the exemption amount, does not live with the taxpayer, or any other restriction which prevents the employee from claiming a dependency exemption for the child either under qualifying child or qualifying relative rules. The provision is also intended to exclude the value of employer-provided coverage under an accident or health plan for injuries or sickness of a child under the age of 27 (IRC §106).

The deduction for health insurance costs of a self-employed individual is extended to apply to any child of a taxpayer who is under the age of 27 at the end of the tax year regardless of whether or not such child is a dependent of the taxpayer (IRC §162(l)(1)).

However, the self-employed taxpayer may not claim the deduction for the cost of health care insurance if the taxpayer is eligible to participate in any subsidized health plan maintained by any employer of a taxpayer's dependent or a child of the taxpayer who is under age 27 at the end of the tax year (IRC §162(l)(2)(B)).

Many states do not automatically conform to Federal tax law changes upon enactment. For those states that do not conform, unless the child is also a dependent as defined under IRC §152(c) (i.e., a qualifying child) or (IRC §152 (d)) (i.e., a qualifying relative) the portion of the premium paid by the employer for medical insurance for the child will be state taxable income to the employee (and not deductible by a taxpayer who is self-employed).

This information will need to be provided to the employer by their health insurance provider, who is knowledgeable regarding how the premium cost is structured. This may mean that the employer has to issue to its employees a state only Form W-2 reporting the state income resulting from this federal change and/or identify this additional amount income in Box 14 of the W-2. States that do not conform include California and Wisconsin. The states of Colorado, Illinois, Kansas and Missouri do conform.

 

Under U.S. Treasury Department guidelines, we hereby inform you that any tax advice contained in this communication is not intended or written to be used, and cannot be used by you for the purpose of avoiding penalties that may be imposed on you by the Internal Revenue Service, or for the purpose of promoting, marketing or recommending to another party any transaction or matter addressed within this tax advice. Further, RubinBrown LLP imposes no limitation on any recipient of this tax advice on the disclosure of the tax treatment or tax strategies or tax structuring described herein.

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