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W-2 Heads Up: Know Your State’s Position on Health Insurance Exemption

W-2 Heads Up: Know Your State’s Position on Health Insurance ExemptionThe health care reform legislation includes a provision for tax-free health insurance benefits for non-dependent children. It was enacted as part of the Health Care and Education Reconciliation Act and became effective the date it was signed into federal law, March 30, 2010. Under this change, the value of employer-provided health insurance coverage of non-dependent children under the age of 27 (as of December 31, 2010) is exempted from employee income.

“Beware, while the IRS will not be taxing this benefit, states will not necessarily follow the federal exemption,” advises Michael Herold, tax principal with LarsonAllen.

State tax treatment will vary
Because this bill was passed before many state legislatures were able to address its impact, the state tax treatment of the benefit will vary. Unless your state passes a specific law adopting this exemption, the employee will pay tax on the “fair market value” of this benefit. “Fair market value” is generally defined as the Consolidated Omnibus Budget Reconciliation Act (COBRA) value, which equates to the employer cost of the health care insurance plus an administrative fee. Employers should use the same COBRA value as when an employee leaves and elects to continue health insurance.

“It is important for both the employer and employee to understand the current state position and discuss the options when preparing W-2s,” Herold says. “Some states have automatically conformed to the tax exclusion and others have outright rejected it.”

Most states have yet to adopt the provisions, and employers are currently awaiting action by their state legislature. In the meantime, employers and employees wonder whether tax should be withheld on these non-dependent benefits.

Here’s an example of how some states are handling it:

  • Wisconsin is requiring tax be withheld on the benefits.
  • Minnesota is suggesting the benefit cost be furnished to the employee who can elect to forgo the withholding, anticipating the Minnesota legislature adopts a tax exemption. Or the employee can play it safe and allow state taxes to be withheld on the post-March, employer-provided health insurance for any non-dependent child.
  • Illinois has already adopted the exemption.

In most cases, a legislative fix at the state level is anticipated, Herold says. Check with your tax advisor if you have questions on your particular situation.


Michael Herold, Tax Principal
mherold@larsonallen.com or 612-376-4548

View our tax principals.

Published: 1/27/2011

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