May 27, 2010 – Minnesota Taxation of Health Care Coverage Provided to Certain Children
Note: The federal tax rules applicable to group health plans are not necessarily the same as applicable state tax rules. This alert focuses on the application of Minnesota’s tax rules, which currently are different from the federal rules.
As we previous reported (here), the health care reform legislation* amended Section 105(b) of the Internal Revenue Code (the “Code”) to add a new category of “dependent” for purposes of the federal taxation of group health coverage. The new category of dependents generally includes the employee’s child who does not attain age 27 by end of tax year (referred to herein as the “employee’s child”). As we noted in the prior alert, the amendment to Section 105(b) had the potential to create some issues with respect to Minnesota income taxation. Now that the Minnesota legislature has adjourned, we have a better picture of the issues for Minnesota employers.
* The Patient Protection and Affordable Care Act , Public Law No. 111-149, and the Health Care and Education Reconciliation Act of 2010, Public Law No. 111-162.
Consider the following:
- Taxable income. For purposes of determining taxable income, Minnesota law currently incorporates a version of the Code that existed prior to the amendment of Section 105(b) by the health care reform legislation. The Minnesota legislature did not act to amend Minnesota law to incorporate the current version of the Code prior to adjourning.
- Wages subject to withholding. For purposes of determining wages subject to withholding, Minnesota law currently incorporates a version of the Code that existed prior to the amendment of Section 105(b) by the health care reform legislation. The Minnesota legislature did not act to amend Minnesota law to incorporate the current version of the Code prior to adjourning.
- Future amendment. It is possible Minnesota law will be amended in the future to incorporate the change to Section 105(b) of the Code. It is also possible such amendments will be effective retroactively. However, until those amendments are enacted, the value of health plan coverage provided to a child who was not a dependent under the old Section 105(b) definition of dependent (often previously referred to as “non-tax dependents”) is taxable income for purposes of Minnesota income tax and is subject to the Minnesota income tax withholding requirements. We have informally confirmed this conclusion with the Minnesota Department of Revenue.
- Medical, dental, and vision coverage. For medical, dental, and vision coverage provided to a child who was not a dependent under the old Section 105(b) definition of dependent, if the cost of coverage is paid on a pre-tax basis (i.e., either by the employer without taxation or by the employee on pre-tax basis through a cafeteria plan), the value of such child’s coverage should be imputed as income to the employee for purposes of Minnesota income tax and withholding requirements.
- Health FSA and HRA reimbursements. If an employer’s health FSA or health reimbursement arrangement (“HRA”) allows a participant to obtain reimbursements of expenses incurred by a child who was not a dependent under the old Section 105(b) definition of dependent (because the plan automatically incorporated the change to Section 105(b) or the plan has been or is amended to do so), the value of such child’s coverage under the health FSA or HRA should be imputed as income to the employee for purposes of Minnesota income tax and withholding requirements.
Important Decision: In light of the withholding requirements under Minnesota law, employers should consider whether to extend coverage under their health FSAs and HRAs to these children at this time. An employer may want to wait to provide such coverage until the Minnesota legislature amends Minnesota law to incorporate the changes to Section 105(b) of the Code or, if applicable, it is required to provide such coverage under the health care reform legislation. [See our forthcoming alert regarding the health care reform legislation’s requirement to provide group health coverage to children until age 26.] This may involve waiting to amend the plan or, if the amendment to Section 105(b) was automatically incorporated into the plan, amending the plan to exclude children who were not dependents under the old rule.
Action Items. In light of the legislature’s failure to amend Minnesota law to incorporate the changes to Code Section 105(b), employers should take the following actions:
- If a child who was not a dependent under the prior version of Section 105(b) is covered under a health plan (e.g., medical, dental, or vision plan), continue imputing income to the employee (equal to the value of the child’s coverage under the plan) for the purpose of Minnesota income tax withholding, provided the employee is not paying for such coverage on an after-tax basis.
- Decide whether expenses incurred by a child who was not a dependent under the prior version of Section 105(b) will be reimbursed under the health FSA and/or HRA and make any amendments to the plan needed to implement the decision.
- If expenses incurred by a child who was not a dependent under the prior version of Section 105(b) will be reimbursed under the health FSA and/or HRA, impute income to the employee (equal to the value of the child’s coverage under the health FSA or HRA) for the purpose of Minnesota income tax withholding.
Please contact us if you have any questions regarding the application of Minnesota tax law, or if you need our assistance with any of the foregoing action items.