One of the most attractive features of a group health plan is that the value of employer-provided health care coverage provided to an employee (and to the employee’s spouse and dependents) is not subject to taxation. This tax-free treatment also applies to reimbursements made under a health care flexible spending account (a “health FSA”).

Under prior law, favorable treatment under a health plan was available in regard to a child of an employee only if the child could be claimed as a dependent of the employee for tax purposes. This meant that an employee could be reimbursed under a health FSA for the medical expenses paid on behalf of a child only if the child was younger than age 19 (or age 23 if a full-time student), and only if the employee provided more than half of the child’s financial support.

A somewhat overlooked provision of the recently enacted Health Care Reform legislation extends the scope of this favorable tax treatment. A discussion of the application of this new tax provision to health FSAs is below.

The Health Care Reform legislation provides that, effective as of March 30, 2010, the group health plan coverage of a child is tax-free through the end of the calendar year in which the child turns age 26. Moreover, the tax-free coverage is available even if the child:

•  Is not the employee’s dependent for tax purposes;
•  Is not a full-time student;
•  Does not reside with the employee;
•  Is not financially supported by the employee; or
•  Is married.

APPLICATION TO HEALTH FSA PLANS

The extension of this special tax-free treatment for health care coverage of children applies to health FSAs and other Section 125 cafeteria plans. In this connection, the IRS (in Notice 2010-38) announced that it intends to amend the Section 125 regulations, effective retroactively to March 30, 2010, to designate the new law allowing the tax-free reimbursement of expenses of children through age 26 as a health FSA “change in status event.” The Notice also states that employers are not required to wait for the regulations to be officially released, and may now permit employees to make a change in status event election.

Example: In 2010, an employee’s 25-year-old daughter is in graduate school. The daughter has a student insurance policy, but the employee pays her dental care expenses and medical out-of-pocket costs. The employee is covered under a health FSA.

In regard to this situation, the employer may now allow the employee to:

• Submit reimbursement requests with respect to the child for expenses incurred on or after March 30, 2010; and
• Make a mid-year change in status event election to increase the employee’s level of salary reduction contribution for the remainder of the year.

If the employer wishes to make this reimbursement right available under the health FSA to account for the reimbursable expenses of the graduate student child this year, it must amend its plan to provide for such. Under the normal IRS rules, a change to an FSA plan can only be implemented if the plan is formally amended before the effective date of the change. However, so as not to cause any delay in offering this extended reimbursement right to employees, the IRS is relaxing its normal requirement, and instead will allow the amendment to be adopted by the end of the current plan year.