Update Regarding the Tax Treatment of Employer-Provided Health Insurance Coverage in Wisconsin
On April 12, 2010, we sent a client alert regarding the federal income tax treatment of employer-provided health insurance coverage in Wisconsin. We have updated this client alert in response to questions from readers regarding the Wisconsin income tax treatment of employer-provided health insurance coverage in Wisconsin and also to reflect new IRS guidance issued on April 27, 2010.
On Tuesday, March 30, 2010, President Obama signed into the law the Health Care and Education Reconciliation Act of 2010 (the “Act”). The Act amended federal tax law (but not Wisconsin tax law – see comments below) so that employers can offer health insurance coverage that is tax-free for federal income tax purposes to adult children of employees during those taxable years in which the children are age 26 or under for the entire taxable year, whether or not those children are tax dependents for federal income tax purposes. For purposes of the new law, “child” means an individual who is a son, daughter, stepson, stepdaughter, or eligible foster child of the taxpayer (employee).
Under the Act, this change is immediately effective and has an immediate impact on many Wisconsin employers. Under Wisconsin law effective on January 1, 2010, employers with group health plans covered by Wisconsin insurance carriers (and self-funded public sector health plans) that offer dependent health insurance coverage to their employees must include coverage for certain adult dependent children up to age 27. When Wisconsin’s new law went into effect, federal tax law required employers to impute as income, to employees covering children who were not tax dependents, the fair market value of health insurance coverage provided to such non-tax dependents. In many cases, adult dependent children that obtain coverage pursuant to Wisconsin’s new law are not tax dependents for federal income tax purposes.
However, the Act amended federal tax law and, effective March 30, 2010, employer-provided health insurance coverage provided to adult children who are age 26 or younger during an entire taxable year is now tax-free for federal income tax purposes to employees, whether or not the adult children are tax dependents for federal income tax purposes.
Thus, Wisconsin employers providing health insurance coverage to adult dependent children up to age 27 are no longer required to impute income for federal income tax purposes to an employee with respect to such coverage or withhold federal income taxes on the fair market value of such coverage except for those taxable years in which a covered child turns 27.
The change in the federal tax code, however, is not retroactive. Accordingly, the fair market value of coverage provided between January 1, 2010, and March 30, 2010, for a child who was not a tax dependent continues to represent taxable income. Employers will still need to treat such coverage as imputed taxable income for federal income tax purposes to the employee for this time period and report it as such on the employee’s Form W-2. Employers should immediately review their payroll practices for imputing income and withholding taxes and make the adjustments necessary to comply with the Act.
Coverage and reimbursements under an employer-provided health plan for an employee’s child are not considered “wages” for FICA and FUTA purposes. On April 27, 2010, the IRS issued Notice 2010-38, in which the IRS states that coverage and reimbursements under an employer-provided health plan for the employees and their dependents are excluded from wages for FICA and FUTA tax purposes. For FICA/FUTA purposes, a “dependent” includes the child of an employee without respect to age, residency, support or any other test normally applicable to a tax dependent. If employers have imputed income for coverage of employee’s children for FICA/FUTA tax purposes, the employers and their employees may be eligible to claim refunds of FICA/FUTA taxes paid on such imputed income.
The IRS also issued guidance addressing cafeteria plans, flexible spending arrangements and health reimbursement arrangements. In Notice 2010-38, the IRS notes that the benefits will not fail to be qualified benefits under a cafeteria plan (including a health FSA) merely because it provides coverage or reimbursements that are excludible from gross income for a child who is age 26 or younger during an entire taxable year. The IRS also announced that it intends to adopt regulations, effective retroactively to March 30, 2010, to include change in status events affecting nondependent children under age 27, including becoming newly eligible for coverage or eligible for coverage beyond the date on which the child otherwise would have lost coverage. The IRS also announced that health reimbursement arrangements may extend the tax treatment described above to an employee’s child under age 27.
The Act did not amend Wisconsin’s income tax law. Wisconsin’s income tax law generally follows the federal law, but Wisconsin has not yet adopted the Act’s changes to the federal tax law. This means that Wisconsin employers probably should continue imputing income for Wisconsin income tax purposes under the old federal tax law. It is possible that the Wisconsin legislature could retroactively adopt, for Wisconsin income tax purposes, the change to the federal tax law, but at this point it is unknown when or if the legislature will do so.
As employers make these adjustments, questions may arise regarding application of the change in the federal tax law, with its March 30, 2010 effective date, to their payroll practices for imputing income and withholding taxes. Michael Best can provide guidance to employers as they adjust their payroll practices to comply with the Act.