WFTRA's Definition of Dependent
The Working Families Tax Relief Act of 2004 (WFTRA) changed the definition of dependent under IRC § 152, effective 2005. While doing so, two new terms were introduced — qualifying child and qualifying relative. . This redefinition created a problem because the WFTRA did not change IRC § 106 when it made corresponding changes to other Code sections.
The consequences of this oversight was that, unless changed, the value of employer-provided coverage for an individual who is not a "qualifying child" and who does not fit within the gross income limitation for a "qualifying relative" would have to be included in the employee's gross income.
On November 17, 2004, the IRS published Notice 2004-79 giving guidance on this issue. In this Notice, IRS says that Congress's intent was not to change the dependent definition for purposes of employer-provided health plans and "an employee may exclude from gross income the value of employer-provided coverage for an individual who meets the definition of a qualifying relative except that the individuals's gross income equals or exceeds the exemption amount."
You will be hearing more in the future on WFTRA because of the effects of the change in the dependent definition under IRC § 152. Not only may it affect who is covered under your health plans and the tax-free status of health benefits for certain dependents,plus, it also affects FSAs and cafeteria plans (including mid-year election changes).
In the case of DCAPs, WFTRA redefines who is a qualifying individual and eliminates the "maintaining a household" requirement for tax-free reimbursements. WFTRA also modifies the dependent definition under HSAs.
You can get a copy of Notice 2004-79at http://www.irs.gov/pub/irs-drop/n-04-79.pdf.