By com TCleary gklaw Todd M. Cleary and com SSkillrud gklaw Sven E. Skillrud, Godfrey & Kahn
Nov. 16, 2011 – On Nov. 4, 2011, Gov. Walker signed legislation (2011 Wisconsin Act 49) that conforms Wisconsin’s income tax treatment with the federal income tax treatment of employer-sponsored health benefits provided to adult children of employees. This change is welcomed by employers and is retroactive to taxable years beginning on Jan. 1, 2011. Now, for federal and Wisconsin income tax purposes, employer-sponsored health benefits provided to an adult child of an employee are tax-free if the adult child has not turned age 27 by Dec. 31 of the applicable tax year.
Prior to this change, there was a disconnect between the federal and Wisconsin income taxation of employer-sponsored health benefits provided to adult children of employees. As part of the federal health care reform legislation passed in 2010, employer-sponsored health plans that provide dependent coverage must also offer that coverage to an eligible employee’s adult child up to age 26, regardless of the child's income, residency, or marital status. An employee’s “child” for this purpose generally includes a son, daughter, stepchild, or adopted child. This coverage mandate applies whether the employer’s plan is insured or self-insured. To minimize the financial consequences associated with this mandatory expansion of health plan coverage, Congress made an adult child’s coverage tax free for federal income tax purposes through the tax year of his or her 26th birthday.
Unfortunately, Wisconsin did not immediately update its state tax code to conform with the Internal Revenue Code (IRC). As a result, prior to Nov. 4, 2011, employers with employees in Wisconsin had to impute income to those employees on the fair market value of an adult child’s health coverage and medical flexible spending account reimbursements if the child did not qualify as a “dependent” for Wisconsin income tax purposes. At that time, a child qualified as an employee’s “dependent” for Wisconsin income tax purposes only if he or she was a dependent under the IRC’s pre-health care reform rules (i.e., the adult child was considered a “qualifying child” or “qualifying relative” of the employee for health plan purposes).
This disjoint between federal and Wisconsin income tax laws, and the concomitant need to impute income and withhold taxes, created significant administrative challenges for affected employers. Further complicating the issue was the fact that the Wisconsin Department of Revenue never provided specific guidance to employers on how to calculate the imputed income. Therefore, employers were often left to wonder whether their fair market value calculations were proper.
How to handle the 2011 tax year
As mentioned above, the new legislation is applicable to all taxable years beginning on or after Jan. 1, 2011. Consequently, for the 2011 tax year (and all future tax years), Wisconsin employers are no longer required to calculate and impute the fair market value of any employer-sponsored health benefits provided to adult children who will be under age 27 at the end of the tax year. This means Wisconsin employers should immediately stop all fair market value calculations and imputation of Wisconsin income with respect to these children. Additionally, be aware that affected employers who were previously imputing Wisconsin income and withholding taxes should not include any imputed Wisconsin income for prior health benefits received by a qualifying adult child on an employee’s 2011 Form W-2.
Employers should not refund any previously withheld Wisconsin income taxes in connection with the imputed income. However, an employer should include the exact amount of Wisconsin taxes withheld on the imputed Wisconsin income in Box 17 of on an employee’s 2011 Form W-2. As a result, an employee will be credited for any previously withheld Wisconsin income taxes when the employee files his or her 2011 Wisconsin income tax return.
Finally, federal and Wisconsin income will need to be imputed for any employer-sponsored health benefits provided to adult children who are age 27 (or older) during the tax year (of course, unless the adult child is considered a “qualifying child” or “qualifying relative” of the employee for health plan purposes). This might be necessary to address recent amendments to Wisconsin insurance law that mandate insured health plans and self-insured governmental health plans provide health benefits to certain adult children until age 27. Although this mandate generally has been eliminated for policy years beginning on or after Jan. 1, 2012, it still could result in the need to impute income with respect to prior coverage.
About the authors
Todd Cleary, Cornell 1999, is a shareholder with Godfrey & Kahn’s Employee Benefits practice group. He works out of the firm's Madison, Milwaukee, and Waukesha offices.
Sven Skillrud, Marquette 2005 cum laude, is an associate with Godfrey & Kahn’s Tax & Employee Benefits practice group. He works primarily out of the firm's Milwaukee office.