Elizabeth Ysla Leight, SPBA Director of Government Relations and Legal Affairs, released this article on March 14, 2011.
Please note that links, bolding and italics have been added by Sterling Health Services Administration.
Under health care reform, changes enacted in 2010 allowed parents to obtain coverage for adult children up to age 26. However, many states have yet to conform their state tax provisions to this change in the health care law. Because of this lack of conformity, employers and taxpayers are confused and face uncertainty about their 2010 taxes and States are scrambling to enact changes.
IRS guidance issued after approval of health reform made clear that employers could provide the coverage tax-free to the employee through the end of the calendar year in which the adult child turns 26. 
Previously, the Tax Code allowed tax relief only if the dependent was age 19 to 24 and a full-time student, or met the requirements of a “qualifying relative”.
What are the States doing?
Generally, States automatically conform their laws to Federal tax law, and some States have said they will amend their laws retroactively to eliminate the tax issue, but it is still a problem for those States that have not done anything. There are approximately 20 States that are not sure they want to go there. This means that employers will face the possibility that their employees who have added adult children to their coverage will face additional State taxes.
California–Laws set up a five-part test which must be satisfied before coverage can be excluded from taxable income including a “support” requirement. So, if an employee added an adult child and did not meet the “support” test, a portion of the premium will be attributable to the child as “taxable wages”.
Another issue: The value of the coverage and how much income would be added to an employees’ W-2 is not clear and varies from state to state.
In Wisconsin, the Department of Revenue says that the if adult child is not a “dependent” then the “fair market value” would be considered income. To date, the regulators in Wisconsin have not provided guidance on how to calculate “fair market value”.
California recently enacted legislation to conform state income tax law to the federal health care law. A.B. 36 would apply to employer provided health coverage, reimbursements from health care flexible spending accounts, costs of health insurance purchased by self-employed parents for their children and VEBAs that provide health care benefits to adult children. It would apply to expenses incurred and benefits provided on or after March 30, 2010 when the federal law went into effect.
What about sharing the tax hit between the adult child and the employee?
Some states are considering attribution to the employee for coverage of the non-dependent adult child. But agree that it would be a big difference between the premium paid to include the child and the premium paid without the child.
Imagine how the calculation would be made if the plan were a self-funded plan or if it was employer paid coverage?
Final thought, it is a big reporting issue and one that you should talk to your elected official about when you go to visit them on Capital Hill and in the State House.
States need to conform their laws with Federal law concerning the tax treatment of employees’ non-dependent adult children.
In the meantime it would take a while. Let’s remember that it took Wisconsin 7 years to amend its tax law to conform to the 2003 Federal law that excludes health saving account contributions from employee taxable income!
Employers with employees in different states–like MD, DC and VA will need to stay on top of these issues.
