On May 13, the Departments of Labor, Health and Human Services and Treasury released interim final rules implementing the mandatory extension of health plan coverage to children up to age 26 under the Patient Protection and Affordable Care Act and the Health Care and Education Reconciliation Act (the Affordable Care Act).

The agencies also issued a Fact Sheet and Frequently Asked Questions regarding health coverage for adult children. This article follows the release of IRS Notice 2010-38, which clarifies the tax treatment of coverage for adult children under the Affordable Care Act.

Background

The Affordable Care Act amends the Public Health Service Act (PHSA), Internal Revenue Code (IRC) and the Employee Retirement Income Security Act to require group health plans and health insurance issuers that provide dependent coverage for children to continue that coverage for children up to age 26, regardless of the child’s dependent status under IRC §152, student status or marital status.

The Affordable Care Act also amends IRC §105(b), effective March 30, 2010, to exclude from an employee’s gross income reimbursements from a health plan for care provided to a child up to age 27. IRC §106 contains a parallel exclusion from gross income for employer-provided health plan coverage.

While IRC §106 was not specifically amended by the Affordable Care Act to exclude coverage extended to children under age 27 from income, Notice 2010-38 indicates that the applicable regulations will be revised to add this exclusion.

Although the extension of coverage to children up to age 26 is mandatory for group health plans as of the first plan year beginning on or after Sept. 23, 2010 (the Effective Date), the requirement generally does not apply to grandfathered group health plans until plan years beginning on or after Jan. 1, 2014.

To the extent that a child under age 26 is not eligible for coverage under another employer-sponsored group health plan (other than a grandfathered plan), however, a grandfathered plan is required to extend coverage to the child as of the Effective Date.

The definition of group health plan in the PHSA, IRC and ERISA is the same definition used for the special enrollment and portability rules of the Health Insurance Portability and Accountability Act. Thus, the coverage mandate does not apply to health plans that provide only excepted benefits, such as stand-alone dental or vision plans.

In contrast, the income tax exclusion is not limited to coverage and benefits under a group health plan, and the exclusions also apply to IRC §401(h) accounts in pension plans and coverage through voluntary employees’ beneficiary associations or for self-employed individuals.

Summary of guidance

The regulations and the notice answer several questions regarding the extension of coverage to adult children and the tax treatment of the extended coverage:

* The federal statute will not supersede any state law requiring the coverage of adult children that imposes a stricter requirement.

* Any plan that offers coverage for dependents will be required to cover children up to age 26 effective as of the first plan year beginning on or after Sept. 23, 2010, with an exception for grandfathered plans as noted above.

* Under Notice 2010-38, employees can exclude from income both the cost of coverage and reimbursements for their adult children beginning March 30, 2010.

* For purposes of the tax exclusions, the term “child” is defined in IRC §152(f)(1) as a son or daughter, stepson or stepdaughter, and a legally adopted (or placed for adoption) child or eligible foster child. In contrast, the regulations do not define “child,” and the preamble notes that the agencies concluded that plan sponsors should have the flexibility to define this term for purposes of their plans, subject to the other rules below.

* As of the effective date, group health plans may not condition or deny coverage to children based on student status, residence with the employee, financial support levels, or status as a dependent under IRC §152(a).

* Notice 2010-38 confirms that coverage and reimbursements received by a participant on behalf of the covered adult child are excludable from the participant’s gross income even if the child does not meet the age limit, residency, support, and other dependency tests set forth in IRC §152(c).

* A group health plan may no longer base the plan’s definition of “dependent” for purposes of eligibility on any factor other than the relationship between the child and the participant, such as financial dependence or place of residence.

* Group health plans also may not vary the terms of the plan based on the age of a child, except for children age 26 or older. Thus, plans will not be able to require a higher premium, for example, for children between age 18 and age 25, nor can the plan restrict adult children to a limited selection of benefit options under the plan.

* If a child is eligible for coverage under the grandfathered plans of both parents, neither plan may exclude the adult child from coverage because the child is eligible to enroll in the plan of the other parent’s employer.

* Group health plans are not required to cover spouses of adult children receiving dependent coverage or employee’s grandchildren. Similarly, Notice 2010-38 provides that the exclusions from income, under IRC §105 and §106, do not extend to such coverage unless the individual is otherwise a dependent of the employee.

Transition rule

The regulations include a transition rule for children who have previously “aged out” under the plan’s terms prior to reaching age 26, or who were older than the plan’s qualifying dependent age when the parent first became eligible to participate in the plan.

Plans must give these children written notice of the availability of coverage and an opportunity to enroll in the plan that lasts at least 30 days. The notice and the enrollment opportunity must be provided no later than the first day of the first plan year beginning on or after Sept. 23, 2010, and coverage may not begin later than that first day of the plan year.

The written notice may be provided to the child through the employee, and may be included in the plan’s open enrollment materials, provided that the notice is prominently displayed.

Adult children enrolling under this transition rule must be treated as special enrollees under HIPAA. Thus, they cannot be required to pay more for coverage than similarly situated individuals who did not lose coverage as a result of the cessation of dependent status.

However, if a plan voluntarily opts to allow continued coverage of adult children before being required to do so under the Affordable Care Act, the preamble says the plan is not required to extend special enrollment to children who will simply continue under the plan without losing coverage.

Finally, children currently covered under COBRA who are eligible for coverage under the transition rule must be given the opportunity to enroll as dependents of an active employee and be provided another COBRA election once they again “age out” of the plan at 26.

Cafeteria plans

Notice 2010-38 clarifies that the coverage for a child under age 27 is a “qualified benefit” that may be elected under a cafeteria plan, including a health flexible spending account.

The Notice provides that the IRS will amend the cafeteria plan rules for change in status events to allow participants to make changes related to the adult child coverage extension, including adding coverage for newly eligible children under age 27. These rules will be amended retroactively to March 30, 2010.

Also, despite the general rule that cafeteria plan amendments must be prospective, cafeteria plans may permit employees to make pre-tax salary reduction contributions immediately for health benefits (including health FSAs) for adult children, provided the plan is amended to allow the contributions no later than Dec. 31, 2010, and the amendment is effective as of the first date employees are permitted to make pre-tax salary reduction contributions to cover children under age 27 (but not earlier than March 30, 2010).

Early implementation

The Secretary of HHS has asked employers to follow the lead of many insurers and extend coverage to adult children as soon as possible, prior to the Effective Date.

The regulations note that early adoption will not affect the status of grandfathered plans. However, employers considering early implementation should understand that several issues remain unclear, including the effect of early implementation on the COBRA obligation for children who would not otherwise be covered until the Effective Date.

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