California employers who last year extended group health coverage to “overage dependents” of their employees – adult children up to age 26 – encountered some difficulties issuing W-2s to those employees in the new year. This is because the state tax definition of a dependent does not match the federal definition. To be a dependent for California tax purposes an adult child must either be disabled or a full-time student, consistent with the federal Internal Revenue Code as of January 1, 2009. (California largely follows the Code as of that date but differs from the Code in several major respects, making it a “selective” conformity state.)
However federal tax guidance that followed PPACA in 2010 now treats adult children as dependents, for federal income tax purposes, through the year in which they turn 26, whether or not they are full-time students, disabled, or meet other requirements of dependent status.
So although this means that the value of health benefits provided to overage dependents is not taxable income to an employee at the federal level, there is “imputed income” to the employee at the state level that must be reflected on Box 16 of Form W-2. Although some employers voluntarily or were required to comply with the age 26 extension last year — affecting W-2s that just went out – it is mandatory in 2011 for “non-grandfathered” group health plans. Even grandfathered plans must offer the coverage to an employee’s adult child if the child does not have other sources of group coverage.
Note that this is the exact inverse of the situation with registered domestic partners, who are the equivalent of spouses for California tax purposes, but who generally are not dependents under the federal tax code. The difficulty for employers in both instances is assigning a value to the benefits provided, this particularly is challenging when the employee is already paying a maxed-out family premium at the time the registered domestic partner or adult child is added to coverage. (Generally the Internal Revenue Service provides that the coverage be assigned a value even when it does not increase premiums; use of the individual COBRA premium less the 2% administrative fee is a good rule of thumb but employers should always consult with their trusted CPA or tax counsel in this regard.)
Fortunately, help is on the way. Late last year, Assembly Bill 1178 was introduced to make California tax law conform to federal law with regard to overage dependents, but the bill failed to pass. The bill has been reintroduced as Assembly Bill 36, sponsored by Democratic Assemblymembers Henry T. Perea and Robert J. Blumenfield. The very brief text of the bill calls for immediately effective tax parity with PPACA regarding dependents. (California law last year was amended to require insurers and HMOs to comply with the PPACA but this measure did not include tax conformity.)
I had the chance to discuss the prospects and timeline for A.B. 36 with a Sacramento legislative consultant. A vote on the bill is scheduled for February 14, 2011 and likely will go to the Senate by the end of February. The Senate could have the bill for anywhere from a week to a month but likely will vote on it by the end of March. As these events hopefully swiftly transpire I will keep you posted on developments. The bill’s prospects for passage are good, but, as with any legislation, never certain.
In the meantime, employers who abandoned the practice of tracking student status for dependents should put those measures back into place, so that employees with adult children who do meet the federal definition of “dependent” can extend coverage to them without any state tax consequences until such time as A.B. 36 becomes law.