- Taxation of Domestic Partner Health Benefits
- September 24, 2008 | Authors: John D. Wahlin; Isabel Cesanto Safie
- Law Firm: Best Best & Krieger LLP - Riverside Office
While the insurance coverage received by a domestic partner or same sex spouse is the same as that of an opposite sex spouse, the tax treatment of health plan coverage and benefits is not always the same.
Status of Domestic Partners Under State and Federal Law. Domestic partners that qualify and register under the California Domestic Partner Rights and Responsibilities Act of 2003 (which became effective January 1, 2005) have the right to the same health coverage benefits as are offered to spouses under a group health plan. In light of a recent California Supreme Court ruling, the same is now true for same sex couples who marry.
Many group health plans now offer coverage for unregistered and opposite-sex domestic partners.
However, domestic partners (registered or not) and same sex spouses are not recognized or treated as spouses under the definition of spouse in the Defense of Marriage Act of September 21, 1996. The result is that the tax treatment of health plan benefits for domestic partners and same sex spouses is determined without reference to their status under State law.
Tax Treatment Under Federal Law. The Internal Revenue Code provides that health care premiums paid by the employer for its employees, their spouses, and the employees’ dependents are not subject to taxation. Benefits provided under the plan are also not taxable. However, benefits for domestic partners do not receive this same favorable tax treatment unless the domestic partner qualifies as a dependent of the employee on his or her federal income tax return. A domestic partner is a “dependent” if he or she (1) lives in the same residence as the person providing support and (2) receives more than ½ of his or her support from the other person.
If the domestic partner is not a dependent, the fair market value of the coverage is taxable to the employee and must be reported as taxable income on Form W-2 for the year received. The IRS has not given specific guidance on how the value of the coverage is determined. The most common approach is to use the amount which would be the COBRA premium for an individual dependent who lost coverage.
The consequences of not following these rules can be disastrous. The IRS has taken the position that the failure to report the value of coverage of a non-dependent partner as taxable to the employee disqualifies the entire plan. This means that all premiums and all benefits paid under the plan are taxable to all participants, not just the affected employee and his or her partner.
It is therefore necessary that the employee confirm the dependent status of the partner. The IRS has stated that it is sufficient to rely on a written certification of the partner’s dependent tax status. That should also be a condition for covering the partner on a pre-tax basis. Since dependent status may change, the employer should obtain an annual certification.
Effect on Section 125 Cafeteria Plan Salary Reduction. Many employers sponsor a Section 125 cafeteria benefit program in which employees pay their share of health plan premiums on a tax-free basis. In newly issued regulations, the IRS confirmed that a cafeteria plan is permitted to provide health coverage to non-dependent individuals. The coverage is still taxable, but it is not necessary that the salary reduction be apportioned between the nontaxable and taxable amounts. Rather, the entire salary reduction may be reported as tax-free so long as the fair market value of the coverage paid by the employer and employee is reported as taxable W-2 income to the employee.