Extension of Dependent Coverage Under California Law May Result in Unforeseen Tax Consequences

California has been at the forefront of implementing the federal health care reform law, the Patient Protection and Affordable Care Act. For example, California was the first state to establish a health insurance exchange program under the Act. However, California's implementation has not been entirely consistent with federal provisions. In 2010, the state enacted a number of bills applying provisions of the federal health care reform legislation in the state, including extending dependent coverage to age 26. On September 30, 2010 Governor Schwarzenegger signed into law SB 1088, (pdf) which requires health insurers and health care services plans that provide dependent coverage of children to extend such coverage until an adult child attains age 26. Mirroring the provisions of the federal law, the California legislation also provides a special enrollment opportunity for children who lost or were denied dependent coverage before they reached age 26. However, California failed to enact legislation to implement a corresponding federal change in the tax treatment of coverage for adult children.

Specifically, Section 1004(d) of the Health Care and Education Reconciliation Act, which amended the Patient Protection and Affordable Care Act, extends the general exclusion from gross income of reimbursements for medical care under an employer-sponsored health plan for an employee's child who has not attained age 27 at the end of the taxable year. The IRS issued guidance to clarify the tax treatment of health care benefits provided for children under age 27. IRS Notice 2010-38 (pdf) states that on or after March 30, 2010, coverage under an employer-sponsored accident or health plan and amounts paid or reimbursed for medical care expenses of an employee's child who has not reached age 27 at the end of the taxable year are excluded from the employee's gross income for federal tax purposes. Although legislation was pending in the California legislature to provide a similar tax break, the bill stalled during the last legislative session. The bill, AB 1178, as amended, would have revised the California Revenue and Taxation Code to conform the exclusion from gross income for state income tax purposes to the federal standard. Instead, California's enactment of the extended dependent coverage mandate without the parallel change to state income tax law means that such coverage may be attributable to the employee's gross income for California income tax purposes.

This entry was written by Ilyse Schuman.