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Working Families Tax Relief Act Of 2004

Overview
The recently passed Working Families Tax Relief Act (WFTRA) of 2004 extends many tax provisions that were set to expire at the end of 2004 or had already expired in 2003. It also introduced some new provisions, as well as some "technical corrections". There are over a dozen new or extended provisions involved in the WFTRA, including the extension of the $1,000 Child Tax Credit through 2009, the renewal of Mental Health Parity and the extension of the Archer Medical Savings Account Program.

From a benefits perspective, most of these changes or extensions don't have an impact on employer-sponsored plans. However, one product of the WFTRA was the creation of a uniform definition of "qualifying child". Prior to the Act, taxpayers had to apply different definitions of "dependent" under the following tax benefits:

1. The dependency exemption,
2. The child credit,
3. The earned income tax credit,
4. The dependent care credit,
5. The head of household filing status.

There are now two ways for an individual to qualify as a dependent- as a "qualifying child" or as a "qualifying relative". For 2005, taxpayers can consider a "qualifying child" as a dependent if the following criteria are met:

1. Taxpayer and child must be related by blood or marriage
   (natural or adopted child, grandchild, sibling, niece, nephew, etc.);
   
   
2. Taxpayer and child must have the same principal residence
   for more than half the year;
   
   
3. Child must be under age 19 by the end of the calendar year
   or 24 if a full-time student;
   
   
4. Child has NOT provided over one-half of his
   or her own support for the year.

A “qualifying relative”, such as an elderly parent, can also be considered a dependent. A qualifying relative must meet the following criteria:

1. Individual does not meet the definition of a “qualified child”;
   
   
2. Individual bears a relationship to the taxpayer (child, sibling, parent, stepparent, niece, nephew, aunt, uncle or parent-in-law). Note: Individual who has the same residence as taxpayer is also considered a member of the household and therefore meets the relationship requirement;
   
   
3. Individual’s gross income is less than $3,200 for 2005;
   
   
4. Individual receives more than half of his or her support from taxpayer.

The Impact on Benefit Plans
Many plans use the IRS’s Section 152 definition of a dependent. Consequently, the revision of this definition may require changes to existing plan documents in order to maintain coverage for some dependents. Below are specific situations where a plan may be impacted.

Dependent Care Assistance Plans (DCAP)
Under a DCAP, employees may be reimbursed for certain dependent care expenses incurred for either a qualifying child under age 13 or a dependent or spouse who is physically or mental incapable of self-care. As such, the following standards now apply to DCAP’s for 2005:

1. Dependents (both qualified children and qualified relatives)
   must reside with the taxpayer for at least half of the year; and
2. Qualifying relatives must have gross income under $3,200 (2005 limit).

The Treasury Department has indicated that employees who have elected coverage under a DCAP who are affected by the passing of the WFTRA may be allowed to make changes to their 2005 election, e.g., drop an adult dependent for coverage or lower their salary reduction in response to the change.

Health Plans/Flexible Spending Accounts
Employers may need to revise their plan documents and summary plan descriptions in response to the WFTRA. Specifically, plans that define eligibility for coverage by referring to “Section 152” or “federal tax dependents” may need to revise their language if they wish to negate the gross income test of $3,200. (The IRS has approved this particular waiver in the case of defining eligibility under a health plan.) Plans that offer coverage for children over age 23 can continue to do so, but the overage child must then meet the criteria of a qualifying relative. If an overage child was covered and didn't meet the criteria of a qualifying relative, the cost of that coverage will likely be taxable to the parent/employee.

Additionally, plans which don’t want to cover domestic partners may need to revise their eligibility language since the IRS’s definition of dependent could now include domestic partners as a qualifying relative. As defined above, a domestic partner would only qualify as a dependent if they met the support, income and residency criteria of a qualifying relative.  

Health Savings Accounts
Unlike other health plans, Health Savings Accounts (HSAs) will only be able to provide benefits for dependents who satisfy ALL of the requirements of Section 152, including the gross income test.

The intention of this article is to summarize the potential impact of the Working Families Tax Relief Act on group benefit plans. The scope of this summary is purposefully limited and is not comprehensive on the entire content of the Act.  Where appropriate, please seek counsel from your company’s advisors or tax professionals.