recent developments

The following is a summary of the most important tax developments that have occurred in the past three months that may affect you, your family, your investments, and your livelihood. Please call us for more information about any of these developments and what steps you should implement to take advantage of favorable developments and to minimize the impact of those that are unfavorable.
Deadline extended for closing home purchase to qualify for homebuyer credit. Relief has been provided to taxpayers who couldn't meet a key June 30, 2010, closing date for qualifying for the homebuyer credit. As a general rule, both the regular first-time homebuyer credit of $8,000 and the reduced credit of $6,500 for long-term residents generally expired for homes purchased after Apr. 30, 2010. However, if a written binding contract to purchase a principal residence was entered into before May 1, 2010, the credit could be claimed if the purchase closed before July 1, 2010. Under the relief measure, if a written binding contract to purchase a principal residence was entered into before May 1, 2010, the credit may be claimed if the purchase is closed before Oct. 1, 2010. Thus, this extension allows homebuyers who signed a contract no later than the April 30th deadline to complete their closing by the end of September.
On June 30, 2010, the Senate passed HR. 5623, the “Homebuyer Assistance Improvement Act of 2010” (the Act) by unanimous consent. The House of Representatives had previously approved H.R. 5623 by a vote of 409-5 on June 29. Thus, the Act, which provides first-time homebuyer credit relief to taxpayers who couldn't meet a key June 30, 2010 closing date, is now cleared for signature by the President.
The cost of the closing reprieve is fully offset by expanding the bad check penalty under Code Sec. 6657 to cover electronic payments, and providing for disclosure of prisoner return information under Code Sec. 6103(k)(10) to state prisons.
Relief for First-Time Homebuyers Unable to Meet Closing Deadline
The Code Sec. 36 first-time homebuyer credit generally is equal to the lesser of $8,000 ($4,000 for a married individual filing separately) or 10% of the principal residence's purchase price. However, for purchases after Nov. 6, 2009, a taxpayer (i.e., a “long-time resident”) may claim the homebuyer credit if he (and, if married, his spouse) maintained the same principal residence for any 5-consecutive year period during the 8-years ending on the date that the taxpayer buys the subsequent principal residence. The maximum allowable homebuyer credit for such taxpayers, who are treated as first time homebuyers for purposes of the first-time homebuyer credit, is $6,500 ($3,250 for a married individual filing separately), or 10% of the purchase price of the subsequent principal residence, whichever is less.
IRS has issued additional guidance on the 2010 payroll tax exemption for hiring unemployed workers and the tax credit for retaining such workers. These payroll tax breaks were enacted by the Hiring Incentives to Restore Employment Act (HIRE Act, P.L. 111-147 ) (see Weekly Alert ¶ 1 03/25/2010 ). The additional guidance, in the form of frequently asked questions (FAQs), carries valuable information on subjects such as the scope of the exemption, how it interacts with other tax breaks, and when an employer must receive the employee's certification of former unemployment status.
Background. The HIRE Act carried two valuable incentives for employers that boost payroll this year: a payroll (FICA) tax exemption for employers that hire unemployed workers; and an up-to-$1,000 tax credit for keeping such new hires on the payroll for at least one year.
Under Code Sec. 3111(d) , qualified employers are exempted from paying the employer 6.2% share of Social Security (i.e., OASDI) employment taxes on wages paid in 2010 to a newly hired qualified individual. The payroll tax relief applies only for wages paid to qualified individuals from Mar. 19, 2010 (the day after the HIRE Act was signed into law by the President) and ending on Dec. 31, 2010.
A qualified employer is any employer other than the U.S., a state, or a political subdivision of a state (i.e., a local government, or an instrumentality). ( Code Sec. 3111(d)(2)(A) ) However, a public institution of higher education is a qualified employer even though it is a government instrumentality. ( Code Sec. 3111(d)(2)(B) )
A qualified individual is an individual who:
(1) begins employment with the employer after Feb. 3, 2010 and before Jan. 1, 2011;
(2) certifies by signed affidavit, under penalties of perjury, that he or she hasn't been employed for more than 40 hours during the 60-day period ending on the date employment begins with the qualified employer;
(3) does not replace another employee of the employer (unless that other employee left voluntarily or for cause); and
(4) is not related to the qualified employer in a way that would disqualify the individual for the work opportunity tax credit (WOTC) under Code Sec. 51(i)(1) . ( Code Sec. 3111(d)(3) )
Unless the employer elects out of the payroll tax exemption, wages paid or incurred to a qualified individual won't qualify for the WOTC during the one-year period beginning on the date that the qualified employer hired the individual. ( Code Sec. 51(c)(5) ) The election can be made on an employee-by-employee basis.
In addition to the payroll tax exemption, HIRE Act Sec. 103 provides employers with an up-to-$1,000 tax credit for retaining “qualified individuals” as defined for Code Sec. 3111(d) purposes. The workers must be employed by the employer for a period of not less than 52 consecutive weeks, and their wages for such employment during the last 26 weeks of the period must equal at least 80% of the wages for the first 26 weeks of the period.
Following are highlights of IRS's new guidance on these payroll tax breaks.
When payroll tax exemption begins and ends. Code Sec. 3111(d)(1) provides that the requirement to pay the employer share of OASDI tax “shall not apply to wages paid by a qualified employer with respect to employment during the period beginning on [March 19, 2010, the day after the enactment date] and ending on December 31, 2010 ....” if all of the payroll tax exemption requirements are met. IRS says that the payroll tax exemption is based on when wages are paid to a qualified employee, not when the wages are earned by such an employee. Thus, only wages paid from Mar. 19 2010, through Dec. 31, 2010, qualify for the exemption, regardless of when those wages were earned. (FAQ PE7)
Form W-11. IRS recently issued Form W-11, Hiring Incentives to Restore Employment (HIRE) Act Employee Affidavit, which newly hired, but formerly unemployed, workers must sign (or its equivalent) in order for their new employers to treat the workers as qualified individuals (see Weekly Alert ¶ 1 04/15/2010 ). The Form W-11 need not be notarized and shouldn't be sent to IRS; the employer should keep the form with its records. (FAQs QE14 and 15)
Form W-11 may be submitted to the employer electronically, if: the electronic transmission is signed via electronic signature by the employee whose name is on the Form W-11; the signature is made under penalties of perjury using the same language that appears on the paper Form W-11; and the electronic signature is the final entry in the employee's Form W-11 submission. Upon IRS's request during an examination, the employer must supply a hard copy of the electronic Form W-11, and a statement that, to the best of the employer's knowledge, the electronic Form W-11 was made by the employee whose name is on the form. The hard copy of the electronic Form W-11 must provide exactly the same information as, but need not be a facsimile of, the paper Form W-11. (FAQ QE18)
Deadline for receipt of Form W-11. The employer must have the signed Form W-11 (or its equivalent) by the time it files an employment tax return applying the payroll tax exemption. If the signed form is obtained after wages are paid to the employee, the employer can still apply the payroll tax exemption to determine its liability on these wages; it may in some cases have to file a corrected return for a prior quarter. (FAQ QE17)
Illustration : ABX hires Anne, an otherwise qualified employee, who begins employment on Mar. 1, 2010 and is paid wages in March. Anne does not provide the signed affidavit until Apr. 15, 2010. ABX can claim the first quarter credit on the second quarter Form 941 for the amount of the exemption with respect to wages paid to Anne from Mar. 19, 2010 through Mar. 31, 2010 and can apply the exemption to wages paid to the qualified employee starting Apr. 1, 2010, despite the fact that Anne did not provide the signed affidavit until Apr. 15, 2010. By contrast, if Anne does not provide the signed affidavit until Aug. 1, 2010, ABX can't claim the first quarter credit on the second quarter Form 941 for wages paid to the qualified employee from Mar. 19, 2010, through Mar. 31, 2010, and can't apply the exemption to wages paid in the second quarter because ABX did not obtain the signed affidavit by the time it filed its second quarter Form 941. Instead, ABX must file a Form 941-X to correct the second quarter of 2010 if it wants to claim the first quarter credit and apply the exemption to the second quarter wages paid to Anne. (FAQ QE17)
Temporary agency employees. A temporary agency can apply the exemption with respect to wages it pays to its qualified employees. This is determined based on when the employee begins employment with the temporary agency, and not based on when the employee begins work at a client business of the temporary agency. (FAQ QE11) If a client business hires an employee who previously provided services to the business as an employee of a temporary agency the client business gets the payroll tax exemption if the worker is a qualified employee when he or she begins employment with the client as its employee. That is, the worker must not have worked as an employee for any business (including the temporary agency) for more than 40 hours in the 60 days prior to beginning employment with the client business. (FAQ QE12)
Election out. Code Sec. 3111(d)(4) provides that a qualified employer may elect, in the manner that IRS requires, not to have the payroll tax exemption apply. IRS says that no formal election out is required; the employer that chooses not to have the payroll tax exemption apply simply reports and pays its share of social security tax on wages paid to qualified employees, along with the employee share of social security tax, Medicare taxes, and withheld income tax. (FAQ PE8)
If an employer applied the payroll tax exemption for a qualified employee on Form 941 for one or more prior quarters, it can later elect out of the exemption by filing Form 941-X for each affected prior quarter to correct its original return and pay the employer's share of social security tax for each such prior quarter. The employer is then eligible to claim the WOTC on its income tax return. (FAQ PE10)
Employer may be selective. An employer can choose to apply the exemption with respect to none, some, or all of its qualified employees. However, if the employer applies the exemption for any wages paid to a particular qualified employee, the exemption must be applied to all wages paid to that employee from Mar. 19, 2010, through Dec. 31, 2010. (FAQ PE 9)
Retention credit and WOTC. An employer may claim the retention credit for a qualified employee (if all the requirements are satisfied) even if it also has claimed the WOTC for the same employee (i.e., even if it has elected out of the payroll tax exemption). (FAQ PE11)
Restaurant employers. Certain food and beverage employers can claim a credit under Code Sec. 45B for social security and Medicare taxes paid or incurred by them on certain employee tips. An employer could be eligible for both the payroll tax exemption and the Code Sec. 45B credit on certain tips if the employer has tipped employees who are also qualified employees under the HIRE Act. The employer claims the payroll exemption on Form 941 and the Code Sec. 45B credit on its income tax return. An employer that applies the payroll tax exemption with respect to a qualified employee will be entitled to a smaller Code Sec. 45B credit because the employer will pay only Medicare tax (and not social security tax) on the employee's wages, including reported tips. (FAQ QR8)

Guidance addresses tax breaks for hiring new employees. Employers are exempted from paying the employer 6.2% share of Social Security (i.e., OASDI) employment taxes on wages paid in 2010 to newly hired qualified individuals. These are workers who: (1) begin employment with the employer after Feb. 3, 2010 and before Jan. 1, 2011, (2) certify by signed affidavit, under penalties of perjury, that they haven't been employed for more than 40 hours during the 60-day period ending on the date the individual begins employment with the qualified employer; (3) do not replace other employees of the employer (unless those employees left voluntarily or for cause), and (4) aren't related to the employer under special definitions. The payroll tax relief applies only for wages paid from Mar. 19, 2010 through Dec. 31, 2010.
Employers may qualify for an up-to-$1,000 tax credit for retaining qualified individuals. The workers must be employed by the employer for a period of not less than 52 consecutive weeks, and their wages for such employment during the last 26 weeks of the period must equal at least 80% of the wages for the first 26 weeks of the period.
The IRS has issued guidance on these tax breaks in the form of frequently asked questions. They carry valuable information on subjects such as the scope of the exemption, how it interacts with other tax breaks, and when an employer must receive the employee's certification of former unemployment status. For example, the IRS explains that the exemption and credit can be claimed for a new employee replacing a downsized employee.
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Detailed guidance released on new small business health care credit. The IRS has issued detailed guidance on the small employer health insurance credit created by the recently-enacted health reform legislation. Under the new law, effective for tax years beginning after Dec. 31, 2009, an eligible small employer (ESE) may claim a tax credit for nonelective contributions to purchase health insurance for its employees. An ESE is an employer with no more than 25 full-time equivalent employees (FTEs) employed during its tax year, and whose employees have annual full-time equivalent wages that average no more than $50,000. However, the full credit is available only to an employer with 10 or fewer FTEs and whose employees have average annual full-time equivalent wages from the employer of not more than $25,000. The new guidance adopts a liberal approach to the new law's requirements, including three alternative methods for figuring total hours of service (important for determining how may FTEs an employer has), and also explains how small employers claim the credit if their State provides a credit or subsidy for employee health coverage. The IRS has released a state-by-state table of average health insurance premiums for the small group market for the 2010 tax year. The table is needed to calculate the credit for this year.
Notice 2010-38, 2010-20 IRB
IRS has issued guidance on the tax treatment of health coverage for children under age 27 under the new health care reform law (which IRS calls the Affordable Care Act). The new under-age-27 rule, which is effective Mar. 30, 2010, applies broadly to employer-provided coverage or reimbursements, cafeteria plans, flexible spending arrangements (FSAs), health reimbursement arrangements (HRAs), voluntary employees' beneficiary associations (VEBAs), and the Code Sec. 162(l) above-the-line deduction for a self-employed individual's medical care insurance costs.
Background. The Affordable Care Act:
(1) Amended Code Sec. 105(b) , effective Mar. 30, 2010, to extend the exclusion for reimbursements for medical care under an employer-provided accident or health plan to any employee's child who has not attained age 27 as of the end of the tax year.
(2) Made amendments parallel to (1), above, effective Mar. 30, 2010, to Code Sec. 401(h) (retiree health accounts in pension plans), Code Sec. 501(c)(9) (VEBAs), and Code Sec. 162(l) (self-employed individual's deductions for medical care insurance).
(3) Amended the Public Health Service Act (PHS Act) to add Sec. 2714, requiring group health plans and health insurance issuers that provide dependent coverage of children to continue to make such coverage available for an adult child until age 26. PHS Sec. 2714 is incorporated into Code Sec. 9815 .
Notice 2010-38 cautions that the rules in PHS Sec. 2714 do not parallel the gross income exclusion rules in Code Sec. 105(b) , Code Sec. 401(h) , Code Sec. 162(l) , as amended by the Affordable Care Act. For example, PHS Sec. 2714 applies to children under age 26 and is effective for the first plan year beginning on or after Sept. 23, 2010, while the changes in (1) and (2), above, apply to children who have not attained age 27 as of the end of the tax year and are effective Mar. 30, 2010.
RIA observation: As example (1) of Notice 2010-38 makes clear, despite the up-to-age-27 rule for exclusion purposes, a health plan may cut off coverage when the employee's child attains age 26.
Following is a summary of the guidance in Notice 2010-38 on the expanded rules for medical coverage of children.
Exclusion for employer-provided medical care reimbursements. As amended by the Affordable Care Act, the Code Sec. 105(b) exclusion is extended to apply to employer-provided reimbursements for expenses incurred by the employee for the medical care of the employee's child (within the meaning of Code Sec. 152(f)(1) ) who has not attained age 27 as of the end of the tax year. “Child” includes the employee's child, stepchild, legally adopted individual, an individual lawfully placed with the employee for legal adoption, and an eligible foster child.
The exclusion applies for an employee's child who has not attained age 27 as of the end of the tax year, including a child who is not the employee's dependent within the meaning of Code Sec. 152(a) . Thus, the Code Sec. 152(c) age limit, residency, support, and other tests do not apply to such a child for Code Sec. 105(b) purposes. The exclusion applies only for reimbursements for medical care of individuals who are not age 27 or older at any time during the tax year.
For purposes of the new rules: the tax year is the employee's tax year; employers may assume that an employee's tax year is the calendar year; a child attains age 27 on the 27th anniversary of the date he was born (e.g., a child born on Apr. 10, '83 attained age 27 on Apr. 10, 2010); and employers may rely on the employee's representation as to a child's date of birth.
Under pre-Affordable Care Act law, the Code Sec. 106 exclusion for employer-provided accident or health plan coverage paralleled the Code Sec. 105(b) exclusion for reimbursements. IRS says there's no indication that Congress intended to provide a broader exclusion in Code Sec. 105(b) than in Code Sec. 106 . Accordingly, IRS will amend the Code Sec. 106 regs retroactively to Mar. 30, 2010, to provide that coverage for an employee's child under age 27 is excluded from gross income.
Illustration : ABC Corp. provides health care coverage for its employees and their spouses and dependents and for any employee's child (as defined in Code Sec. 152(f)(1) ) who has not attained age 27 as of the end of the tax year. For the 2010 tax year, ABC provides health care coverage to Employee Earl and to Gene, who is Earl's son. Gene, who isn't Earl's dependent, never worked for ABC and won't attain age 27 until after the end of 2010. The health care coverage and reimbursements for Gene under ABC's plan are excludible from Earl's gross income for the period on and after Mar. 30, 2010 through the end of 2010 tax year. That's true whether Gene is ineligible for health coverage from his own employer's plan, or is eligible do so but declines coverage under his own company plan. ( Notice 2010-38 , Exs. 2 and 3)
Cafeteria plans, FSAs and HRAs. The Code Sec. 105(b) / Code Sec. 106 exclusion for coverage of an employee's child who has not attained age 27 carries forward automatically to the definition of qualified benefits for Code Sec. 125 cafeteria plans, including health FSAs.
Under Reg. § 1.125-4(c) , a cafeteria plan may permit an employee to revoke an election during a period of coverage and to make a new election only in limited circumstances, such as a change in status event (e.g., changes in the number of an employee's dependents). However, the reg doesn't currently permit election changes for children under age 27 who are not the employee's dependents. IRS will amend the reg, effective retroactively to Mar. 30, 2010, to include change in status events affecting nondependent children under age 27, including becoming newly eligible for coverage or eligible for coverage beyond the date on which the child otherwise would have lost coverage.
The same rules that apply to an employee's child under age 27 for Code Sec. 105(b) and Code Sec. 106 purposes also apply to an HRA.
Transition rule for cafeteria plan amendments. Cafeteria plans may need to be amended to include employees' children who have not attained age 27 as of the end of the tax year. Despite the general rule in Reg. § 1.125-1(c) that cafeteria plan amendments may be effective only prospectively, as of Mar. 30, 2010, employers may permit employees to immediately make pre-tax salary reduction contributions for accident or health benefits under a cafeteria plan (including a health FSA) for children under age 27, even if the plan has not yet been amended to cover these individuals. However, a retroactive amendment to a cafeteria plan to cover children under age 27 must be made no later than Dec. 31, 2010, and must be effective retroactively to the first date in 2010 when employees are permitted to make pre-tax salary reduction contributions to cover children under age 27 (but not before Mar. 30, 2010).
Payroll- and income-tax withholding. Coverage and reimbursements under a plan for employees and their dependents that are provided for an employee's child under age 27 are not wages for FICA (Federal Insurance Contributions Act), FUTA (Federal Unemployment Tax Act), or RRTA (Railroad Retirement Act) purposes, and such coverage and reimbursements also are exempt from income tax withholding.
VEBAs, Code Sec. 401(h) accounts, and Code Sec. 162(l) deductions. A VEBA is a tax-exempt entity described in Code Sec. 501(c)(9) providing for the payment of life, sick, accident, or other benefits to its members or their dependents or designated beneficiaries. IRS intends to amend the VEBA regs to include children (as defined in Code Sec. 152(f)(1) ) who are under age 27 with respect to sick and accident benefits. Similarly any individual who is a retired employee's child (within the meaning of Code Sec. 152(f)(1) ), and who has not attained age 27 as of the end of the calendar year, may be covered under Code Sec. 401(h) , which provides that a pension or annuity plan can establish and maintain a separate account to provide for the payment of benefits for sickness, accident, hospitalization, and medical expenses of retired employees, their spouses and their dependents if certain enumerated conditions are met.
Under Code Sec. 162(l) , a self-employed individual may deduct, in computing adjusted gross income, amounts paid during the tax year for insurance that constitutes medical care for the taxpayer, spouse, and dependents, if certain requirements are satisfied. As amended by the Affordable Care Act, Code Sec. 162(l) covers medical insurance for any child (within the meaning of Code Sec. 152(f)(1) ) who hasn't attained age 27 as of the end of the tax year.
Effective date. The changes relating to Code Sec. 105(b) , Code Sec. 401(h) , and Code Sec. 162(l) , are effective on Mar. 30, 2010. Taxpayers may rely on Notice 2010-38 pending the issuance of amended regs

Guidance issued on new under-age-27 rule for health coverage of children. The IRS has issued guidance on the tax treatment of health coverage for children under age 27 under the new health reform law. The new under-age-27 rule, which went into effect March 30, 2010, applies broadly to employer-provided coverage or reimbursements, cafeteria plans, flexible spending arrangements (FSAs), health reimbursement arrangements (HRAs), voluntary employees' beneficiary associations (VEBAs), and the above-the-line deduction for a self-employed individual's medical care insurance costs.

Availability of FICA exception for medical residents to be resolved. The Supreme Court has agreed to review a 2009 decision of the Court of Appeals for the Eighth Circuit, which upheld the validity of regulations that generally prevent medical residents from qualifying for the FICA student exception. Under these regulations, an employee includes a medical resident who works 40 hours or more for a school, college or university is not eligible for the student exception. The Supreme Court will now decide their validity. Its decision will have important ramifications for the many teaching hospitals and their residents.
States address estate planning uncertainty. As of now, there is no estate or generation-skipping transfer (GST) tax for individuals who die this year. There are issues as to how formula clauses in wills and trusts using estate or GST tax terms (e.g., “the applicable exclusion amount,” or “the marital deduction”) will be construed, if the decedent dies in 2010. Several states have addressed this situation by enacting laws providing a special rule of construction under which formula clauses that refer to certain estate and GST tax terms generally will be construed as referring to the federal estate tax and GST tax laws which applied to estates of decedents dying on Dec. 31, 2009. These statutes could impact the amount that will pass under one's will to a person's spouse and children.

Deadline extended for retirement plans in federally declared disaster areas in eight States. The IRS has administratively extended to July 30, 2010, the April 30, 2010, deadline for restating affected pre-approved defined contribution plans and, if applicable, for submitting determination letters to the IRS, and the Code Sec. 401(b) remedial amendment period for these retirement plans. The relief applies to sponsors of defined contribution plans that were affected by the storms and other severe weather in counties in Alabama, Connecticut, Massachusetts, Mississippi, New Jersey, Rhode Island, Tennessee and West Virginia that were federally declared disaster areas in the period from March 1 through May 31, 2010.

Therapeutic Discovery Project Program implemented. The IRS has established the guidelines for applying for the new Therapeutic Discovery Project Program created by the recently enacted health reform legislation. The program will provide tax credits and grants to small firms that show significant potential to produce new and cost-saving therapies, support good jobs and increase U.S. competitiveness. Small firms may apply for certification for tax credits or grants under the program on Form 8942, which must be postmarked no later than July 21, 2010.
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Temporary regulations fill in statutory gaps on new indoor tanning tax. The IRS has issued temporary regulations on the health reform's legislation's new 10% excise tax on indoor tanning services provided on or after July 1, 2010. The regs address practical considerations that may not have been contemplated when the law was drafted. For example, they addresses prepayments for tanning services and services provided as part of a gym membership.
Notice 2010-38, 2010-20 IRB
IRS has issued guidance on the tax treatment of health coverage for children under age 27 under the new health care reform law (which IRS calls the Affordable Care Act). The new under-age-27 rule, which is effective Mar. 30, 2010, applies broadly to employer-provided coverage or reimbursements, cafeteria plans, flexible spending arrangements (FSAs), health reimbursement arrangements (HRAs), voluntary employees' beneficiary associations (VEBAs), and the Code Sec. 162(l) above-the-line deduction for a self-employed individual's medical care insurance costs.
Background. The Affordable Care Act:
(1) Amended Code Sec. 105(b) , effective Mar. 30, 2010, to extend the exclusion for reimbursements for medical care under an employer-provided accident or health plan to any employee's child who has not attained age 27 as of the end of the tax year.
(2) Made amendments parallel to (1), above, effective Mar. 30, 2010, to Code Sec. 401(h) (retiree health accounts in pension plans), Code Sec. 501(c)(9) (VEBAs), and Code Sec. 162(l) (self-employed individual's deductions for medical care insurance).
(3) Amended the Public Health Service Act (PHS Act) to add Sec. 2714, requiring group health plans and health insurance issuers that provide dependent coverage of children to continue to make such coverage available for an adult child until age 26. PHS Sec. 2714 is incorporated into Code Sec. 9815 .
Notice 2010-38 cautions that the rules in PHS Sec. 2714 do not parallel the gross income exclusion rules in Code Sec. 105(b) , Code Sec. 401(h) , Code Sec. 162(l) , as amended by the Affordable Care Act. For example, PHS Sec. 2714 applies to children under age 26 and is effective for the first plan year beginning on or after Sept. 23, 2010, while the changes in (1) and (2), above, apply to children who have not attained age 27 as of the end of the tax year and are effective Mar. 30, 2010.
RIA observation: As example (1) of Notice 2010-38 makes clear, despite the up-to-age-27 rule for exclusion purposes, a health plan may cut off coverage when the employee's child attains age 26.
Following is a summary of the guidance in Notice 2010-38 on the expanded rules for medical coverage of children.
Exclusion for employer-provided medical care reimbursements. As amended by the Affordable Care Act, the Code Sec. 105(b) exclusion is extended to apply to employer-provided reimbursements for expenses incurred by the employee for the medical care of the employee's child (within the meaning of Code Sec. 152(f)(1) ) who has not attained age 27 as of the end of the tax year. “Child” includes the employee's child, stepchild, legally adopted individual, an individual lawfully placed with the employee for legal adoption, and an eligible foster child.
The exclusion applies for an employee's child who has not attained age 27 as of the end of the tax year, including a child who is not the employee's dependent within the meaning of Code Sec. 152(a) . Thus, the Code Sec. 152(c) age limit, residency, support, and other tests do not apply to such a child for Code Sec. 105(b) purposes. The exclusion applies only for reimbursements for medical care of individuals who are not age 27 or older at any time during the tax year.
For purposes of the new rules: the tax year is the employee's tax year; employers may assume that an employee's tax year is the calendar year; a child attains age 27 on the 27th anniversary of the date he was born (e.g., a child born on Apr. 10, '83 attained age 27 on Apr. 10, 2010); and employers may rely on the employee's representation as to a child's date of birth.
Under pre-Affordable Care Act law, the Code Sec. 106 exclusion for employer-provided accident or health plan coverage paralleled the Code Sec. 105(b) exclusion for reimbursements. IRS says there's no indication that Congress intended to provide a broader exclusion in Code Sec. 105(b) than in Code Sec. 106 . Accordingly, IRS will amend the Code Sec. 106 regs retroactively to Mar. 30, 2010, to provide that coverage for an employee's child under age 27 is excluded from gross income.
Illustration : ABC Corp. provides health care coverage for its employees and their spouses and dependents and for any employee's child (as defined in Code Sec. 152(f)(1) ) who has not attained age 27 as of the end of the tax year. For the 2010 tax year, ABC provides health care coverage to Employee Earl and to Gene, who is Earl's son. Gene, who isn't Earl's dependent, never worked for ABC and won't attain age 27 until after the end of 2010. The health care coverage and reimbursements for Gene under ABC's plan are excludible from Earl's gross income for the period on and after Mar. 30, 2010 through the end of 2010 tax year. That's true whether Gene is ineligible for health coverage from his own employer's plan, or is eligible do so but declines coverage under his own company plan. ( Notice 2010-38 , Exs. 2 and 3)
Cafeteria plans, FSAs and HRAs. The Code Sec. 105(b) / Code Sec. 106 exclusion for coverage of an employee's child who has not attained age 27 carries forward automatically to the definition of qualified benefits for Code Sec. 125 cafeteria plans, including health FSAs.
Under Reg. § 1.125-4(c) , a cafeteria plan may permit an employee to revoke an election during a period of coverage and to make a new election only in limited circumstances, such as a change in status event (e.g., changes in the number of an employee's dependents). However, the reg doesn't currently permit election changes for children under age 27 who are not the employee's dependents. IRS will amend the reg, effective retroactively to Mar. 30, 2010, to include change in status events affecting nondependent children under age 27, including becoming newly eligible for coverage or eligible for coverage beyond the date on which the child otherwise would have lost coverage.
The same rules that apply to an employee's child under age 27 for Code Sec. 105(b) and Code Sec. 106 purposes also apply to an HRA.
Transition rule for cafeteria plan amendments. Cafeteria plans may need to be amended to include employees' children who have not attained age 27 as of the end of the tax year. Despite the general rule in Reg. § 1.125-1(c) that cafeteria plan amendments may be effective only prospectively, as of Mar. 30, 2010, employers may permit employees to immediately make pre-tax salary reduction contributions for accident or health benefits under a cafeteria plan (including a health FSA) for children under age 27, even if the plan has not yet been amended to cover these individuals. However, a retroactive amendment to a cafeteria plan to cover children under age 27 must be made no later than Dec. 31, 2010, and must be effective retroactively to the first date in 2010 when employees are permitted to make pre-tax salary reduction contributions to cover children under age 27 (but not before Mar. 30, 2010).
Payroll- and income-tax withholding. Coverage and reimbursements under a plan for employees and their dependents that are provided for an employee's child under age 27 are not wages for FICA (Federal Insurance Contributions Act), FUTA (Federal Unemployment Tax Act), or RRTA (Railroad Retirement Act) purposes, and such coverage and reimbursements also are exempt from income tax withholding.
VEBAs, Code Sec. 401(h) accounts, and Code Sec. 162(l) deductions. A VEBA is a tax-exempt entity described in Code Sec. 501(c)(9) providing for the payment of life, sick, accident, or other benefits to its members or their dependents or designated beneficiaries. IRS intends to amend the VEBA regs to include children (as defined in Code Sec. 152(f)(1) ) who are under age 27 with respect to sick and accident benefits. Similarly any individual who is a retired employee's child (within the meaning of Code Sec. 152(f)(1) ), and who has not attained age 27 as of the end of the calendar year, may be covered under Code Sec. 401(h) , which provides that a pension or annuity plan can establish and maintain a separate account to provide for the payment of benefits for sickness, accident, hospitalization, and medical expenses of retired employees, their spouses and their dependents if certain enumerated conditions are met.
Under Code Sec. 162(l) , a self-employed individual may deduct, in computing adjusted gross income, amounts paid during the tax year for insurance that constitutes medical care for the taxpayer, spouse, and dependents, if certain requirements are satisfied. As amended by the Affordable Care Act, Code Sec. 162(l) covers medical insurance for any child (within the meaning of Code Sec. 152(f)(1) ) who hasn't attained age 27 as of the end of the tax year.
Effective date. The changes relating to Code Sec. 105(b) , Code Sec. 401(h) , and Code Sec. 162(l) , are effective on Mar. 30, 2010. Taxpayers may rely on Notice 2010-38 pending the issuance of amended regs

Notice 2010-45, 2010-23 IRB
In a notice, accompanied by a Treasury release and fact sheet, the administration has announced the guidelines for applying for the new Therapeutic Discovery Project Program created by the Patient Protect and Affordable Care Act (Affordable Care Act, P.L. 111-148 ). As noted in the guidance, the program will provide tax credits and grants to small firms that show significant potential to produce new and cost-saving therapies, support good jobs and increase U.S. competitiveness.
Click here for the Treasury Release on the therapeutic tax credit.
Click here for the fact sheet on the therapeutic tax credit.
Background. For expenses paid or incurred after Dec. 31, 2008, there is a new 50% investment tax credit for qualified investments in qualifying therapeutic discovery projects (QTDPs). ( Code Sec. 48D ) The provision allocates $1 billion during the two-year period 2009 through 2010 for the program. IRS, in consultation with the Secretary of Health and Human Services (HHS), will award certifications for qualified investments. The credit is available only to companies having 250 or fewer employees. ( Code Sec. 48D(c)(2) )
A mechanism exists to allow the taxpayer to receive a grant in lieu of a tax credit. ( Code Sec. 48D(f) )
RIA observation: The grant option allows startups that are not yet profitable to benefit from the credit.
The qualified investment for a tax year is the aggregate amount of the costs paid or incurred in the tax year for expenses necessary for and directly related to the conduct of a QTDP. Additionally, the costs must satisfy certification and timing requirements (see below) and can't be excluded costs (see below). ( Code Sec. 48D(b) )
The amount that is treated as qualified investment for all tax years for any QTDP can't exceed the amount certified by IRS as eligible for the QTDP credit. ( Code Sec. 48D(b)(2) )
An investment is considered a qualified investment under Code Sec. 48D(b) only if it is made in a tax year beginning in 2009 or 2010. ( Code Sec. 48D(b)(2) )
The qualified investment for any tax year with respect to any QTDP does not include any cost for: (1) remuneration for an employee described in Code Sec. 162(m)(3) , (2) interest expense, (3) facility maintenance expenses, (4) a service cost identified under Reg. § 1.263A-1(e)(4) , or (5) any other expenditure as determined by IRS as appropriate to carry out the purposes of Code Sec. 48D . ( Code Sec. 48D(b)(3) )
A “qualifying therapeutic discovery project” is one which is designed to develop a product, process, or therapy to diagnose, treat, or prevent diseases and afflictions by: (1) conducting pre-clinical activities, clinical trials, clinical studies, and research protocols, or (2) by developing technology or products designed to diagnose diseases and conditions, including molecular and companion drugs and diagnostics, or to further the delivery or administration of therapeutics. ( Code Sec. 48D(c)(1) )
Not later than May 21, 2010, IRS, in consultation with the Secretary of HHS, must establish a QTDP program to consider and award certifications for qualified investments eligible for the QTDP credit to qualifying therapeutic discovery project sponsors. Each applicant for certification must submit an application containing the information IRS may require during the period beginning on the date that IRS establishes the program. ( Code Sec. 48D(d) )
Qualified therapeutic discovery project expenditures do not qualify for the research credit, orphan drug credit, or bonus depreciation. If a QTDP credit is allowed under Code Sec. 48D for an expenditure related to property of a character subject to an allowance for depreciation, the basis of the property must be reduced by the amount of the credit. Additionally, expenditures taken into account in determining the credit are nondeductible to the extent of the credit claimed that is attributable to such expenditures. ( Code Sec. 48D(e) )
Projects to which credit is targeted. The new guidance says that the credit is targeted to projects that show significant potential to produce new therapies, address unmet medical needs, reduce the long-term growth of health care costs and advance the goal of curing cancer within the next 30 years. The credit's allocation will take into consideration which projects show the greatest potential to create and sustain high-quality, high-paying jobs in the U.S. and to advance U.S. competitiveness in the fields of life, biological, and medical sciences.
Certification process. Notice 2010-45 establishes the QTDP program and provides the procedures under which an eligible taxpayer may apply for certification from IRS of a qualified investment with respect to a QTDP as eligible for a credit, or for certain taxpayers, a grant under the program. IRS will consult with HHS in conducting the program.
IRS will certify an eligible taxpayer's qualified investment associated with a QTDP, for which an application has been submitted under Notice 2010-45, Sec. 6 , only if:
(1) HHS determines that the taxpayer's project is a QTDP;
(2) HHS determines that the taxpayer's project shows reasonable potential (a) to result in new therapies (i) to treat areas of unmet medical need, or (ii) to prevent, detect, or treat chronic or acute diseases and conditions, (b) to reduce long-term health care costs in the U.S., or (c) to significantly advance the goal of curing cancer within the 30-year period beginning on May 21, 2010; and
(3) IRS determines that the taxpayer's project is among those projects that have the greatest potential (a) to create and sustain (directly or indirectly) high quality, high-paying jobs in the U.S., and (b) to advance U.S. competitiveness in the fields of life, biological, and medical sciences. ( Notice 2010-45, Sec. 5.01 )
Detailed program specifications are set forth in Notice 2010-45, Sec. 5.01 .
A separate application for certification must be submitted for each project for which an eligible taxpayer is seeking certification of a qualified investment. Applications for certification will be made on Form 8942, “Application for Certification of Qualified Investments Eligible for Credits and Grants Under the Qualifying Therapeutic Discovery Project Program.” It will provide the manner for submitting applications and will be released no later than June 21, 2010. The formal application window will extend from June 21 to July 21, 2010. Applicants will receive a determination no later than Oct. 29, 2010.
An application must include all of the information required by Form 8942 and meet the requirements in Notice 2010-45, Sec. 7.01 and Notice 2010-45, Sec. 7.02 , or IRS and HHS may decline to consider it. ( Notice 2010-45, Sec. 6.01 )
Grants instead of credit. Notice 2010-45, Sec. 8.01 , provides background on the option of seeking a grant rather than a credit and Notice 2010-45, Sec. 8.02 , provides application procedures for grants. Among other requirements, an applicant must affirmatively elect on Form 8942 to apply for a grant for 2009 or 2010. ( Notice 2010-45, Sec. 8.02(1) ) It should be noted that an election to apply for a grant must include the applicant's Data Universal Numbering System (DUNS) number from Dun and Bradstreet. If the applicant does not already have a DUNS number, it may request one at no cost by calling the dedicated toll-free DUNS Number request line at 1-866-705-5711.