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EXPANDED DEPENDENT COVERAGE RESULTS IN EXPANDED TAX LIABILITY FOR SOME EMPLOYEES by Sandy Reynolds

The Massachusetts Health Care Reform law includes a provision that expands dependent eligibility beyond the age of 19 even when the dependent is not a full-time student. The provision, effective January 1, 2007, applies to all insured group health plans sold in Massachusetts and allows for coverage until age 26 or two years following the loss of IRS dependent status—whichever comes first.

To encourage the offer and acceptance of employee benefit plans, the federal government, along with most states, affords very favorable tax treatment. In simplified terms, employers are not taxed on the funds used to purchase the benefits, and we, as employees, do not have the value of the benefits added to our taxable income.

In order to protect this favorable treatment, for employer and employees, all rules set forth by the IRS must be followed. One of the rules is that the “fair market value” of coverage for individuals who do not meet the federal definition of “dependent” must be taxed as imputed income for employees who carry the coverage.

Significant problems arose since the Health Care Reform statute did not specify exactly which of the many IRS definitions of “dependent” applies in the new dependent eligibility provision.

Also, since Mass. taxable income is, by definition, the same as federal taxable income, the value would also be taxable for state purposes—an unintended penalty for taking advantage of a new benefit created by the state.

A technical corrections bill, including the Mass. Department of Revenue’s (DOR’s) clarifying language on this issue, has just been passed by the legislature and signed by Governor Patrick. While formal guidance has not yet been released by the DOR, the following information should be helpful to employers and employees who have an interest in this issue as the 2007 tax year nears a close:

• There will be no state income tax liability resulting from coverage under the expanded dependent eligibility rules.

• It is possible that the fair market value of coverage gained under the expanded eligibility rules will be taxable for federal purposes in some cases and non-taxable in others.

• Some employers have withheld tax this year from employees who may not owe it. Many other employers have not begun withholding taxes and may have employees who should be taxed.

Employers are urged watch for the forthcoming DOR guidance—through business groups, such as AIM, law firms, benefits or payroll services, etc., as well as through the DOR and the media. Counsel from a qualified tax or benefits attorney, or other specialist, is also encouraged. It is very possible that W-2s will need to be amended after the end of this tax year.

Employees who have elected to cover dependents over the age of 19 who are not full-time students (and not disabled) are encouraged to ensure that they fully understand the tax implications that result from their election, for 2007 and for future tax years.

Sandy Reynolds, Executive Vice President
Associated Industries of Massachusetts (AIM)

This program aired on December 4, 2007. The audio for this program is not available.

Martha Bebinger Twitter Reporter
Martha Bebinger covers health care and other general assignments for WBUR.

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