Expanded Health Benefits Coverage for Dependents What to Know Regarding Taxation

By David Law, Esq. and Richard C. Dwyer

The New Hampshire State Legislature passed several laws during the 2007 session that expand the availability of group health plan coverage and also raise certain federal taxation issues. As a pooled risk management program, New Hampshire Local Government Center (LGC) is not subject to State insurance laws, per New Hampshire RSA Chapter 5-B. However, LGC’s Board of Directors regularly reviews laws impacting group health plan coverage and determines whether to follow the provisions of such laws in administering benefit programs.

This article summarizes the healthcare-related laws passed in New Hampshire last year, LGC’s response to the laws and the federal tax implications of coverage for non-tax qualified dependents noted in italics.

HB 790
Extends medical and dental coverage for eligible dependents up to age 26. Effective September 15, 2007.
LGC has expanded the dependent child definition under its plans to be consistent with this law.

SB 197
Allows divorced spouses to remain on the subscriber’s policy for up to three years. Effective January 1, 2008.
LGC has decided not to offer this additional continuation of coverage benefits under its plans but will continue to offer standard COBRA continuation rights to divorcing spouses.

HB 437
Permits same gender couples to enter civil unions and have the same rights, responsibilities and obligations under New Hampshire law as married couples, including access to medical and dental coverage. Effective January 1, 2008.
LGC has made coverage available under its plans to civil union couples in the same manner as for married couples.

Dependent Coverage
Consistent with the intent of HB 790, LGC will provide coverage under its medical/dental programs for qualified dependent children between the ages of 19 and 26. Previously, dependent children were generally eligible only until age 19, or age 25 if a full-time student. In order to qualify under the new rules, a dependent must:

  • Be under age 26
  • Be unmarried
  • Not be covered under any other health plan
  • Be a resident of New Hampshire or enrolled at an out-of-state public or private institution of higher education. (HB 790 does not require full-time student status for dependent children.)

This expanded definition of eligible dependent children may result in federal tax consequences for the employer and the employee. The relevant tax rules are summarized in the “Taxation Implications" portion of this article.

Divorced Spouses
This law requires insured health plans to allow a former spouse to continue coverage with the group at the group rate and be subject to the group’s continuing subsidy, if any, for up to three years as if the divorce did not occur. Customarily, the divorced spouse would be placed on an individual COBRA continuation policy with payment by the employee or the former spouse being decided by the parties or divorce decree.

As previously noted, LGC will not be extending the additional coverage for divorced spouses pursuant to SB 197. It will, however, continue to offer the standard COBRA coverage rights currently being offered.

Civil Unions
Health plans sponsored by LGC will comply with all provisions of the civil union legislation, allowing partners in a civil union the same access to medical benefits as would be afforded to those in a marriage. Both the civil union partner and his/her dependents may be covered by the medical plan, but there are taxation issues.

Unless a civil union partner and dependents are considered tax dependents of the employee (which is not usually the case), the employee will have additional taxable income based on the value of coverage provided to the non-tax dependent as detailed in the next section.

Tax Implications
Under federal tax law, only certain dependents of an employee may qualify to receive employer-provided health coverage on a tax-free basis. If coverage is provided to a dependent who is not considered a “qualified tax dependent" per Sections 152 and 105(b) of the Internal Revenue Code (IRC), federal income and payroll tax consequences will result. The employee will incur additional taxable income or “imputed income."

Income will be imputed to the employee based upon the fair market value of coverage provided for the non-tax qualified dependent. The imputed income, like other wages, will be subject to income tax withholding and payroll taxes (for example, Social Security and Medicare). The employee’s share of premium contributions for the non-tax qualified dependent’s coverage may be paid on a pre-tax basis through an IRC Section 125 premium payment or flexible benefit plan provided (1) the group’s 125 plan so allows, and (2) the full fair market value of the non-tax dependent’s coverage is included in the employee’s income. Please note that healthcare expenses of a non-tax dependent are not reimbursable under a healthcare flexible spending account.

Qualified Tax Dependent
If, however, the employee can certify to the employer’s satisfaction that the dependent being enrolled is a qualified tax dependent, the dependent’s coverage under the employer’s group medical and/or dental plan will be tax-free and not subject the employee to imputed income. For a dependent to be a qualified tax dependent for medical/dental plan purposes, certain requirements in IRC Sections 152 and 105(b) (definition of “dependent") must be satisfied. In general, the child must be the employee’s biological, adopted or stepchild and the employee must provide over one-half of the child’s support during the relevant calendar year. Also, the child may not be claimed as a qualifying dependent child by any other taxpayer for the relevant year. Special rules apply to disabled children and children of divorced parents.

Based on these tax rules, if the employee is able to claim the dependent child or civil union partner as a dependent on the employee’s federal income tax return for the year in which health plan coverage is being provided, the dependent will qualify for tax-free coverage. However, if the employee cannot claim the dependent as a dependent on the tax return and the dependent is self-supporting, the dependent’s health plan coverage will be subject to federal taxation under the imputed income and related rules described above.

Please note that the standard for claiming a child as a tax dependent for health plan coverage purposes is not as strict as for claiming an exemption for the child on the employee’s tax return. Therefore, if the employee provides over 50 percent of the child’s support in the relevant year, the child may qualify for the health plan tax exclusion even if the employee may not claim an exemption for the child on the employee’s tax return.

Taxable Amount
As previously stated, the amount of imputed wage income to the employee for health coverage provided to a non-tax qualified dependent will be based on the fair market value of the coverage. In general, the IRS defines fair market value of such benefit coverage as the amount that an individual would have to pay for that coverage in an arm’s length transaction. For LGC, this amount usually means the cost of COBRA coverage. Other employers use different methodologies to determine the fair market value of benefits. Employers need to determine the specific amount of imputed income that will apply to coverage of any non-tax dependents.

The information in this article is only a summary of the tax provisions governing group health plan coverage for dependents and is not intended, nor should it be relied upon, as legal or tax advice. Due to the complexity of the described tax rules and potential impact of any imputed income an employee may incur, the employee should always seek advice from a competent tax professional before certifying the tax status of a dependent being enrolled in a health plan.

David Law is an attorney at Cleveland Waters & Bass of Concord, NH, and specializes in employee benefits and tax law. Richard Dwyer is Operations Manager at New Hampshire Local Government Center.