Federal Tax Treatment of Employer-Provided Health Insurance for Domestic Partners

To fully understand the tax treatment of the receipt of employer-provided health benefits by an employee’s domestic partner (regardless of the domestic partner’s gender), one must first understand the tax treatment of the receipt of employer-provided health benefits by an employee1, the employee’s spouse, and the employee’s dependents2.

Employers can deduct the cost of employer-provided health insurance as a Section 162 ordinary and necessary business expense. An employee’s receipt of benefits from his/her employer constitutes income for purposes of Section 61 of the Internal Revenue Code of 1986, as amended (the “Code”). For example, but for a specific statutory provision, the cost of employer-provided health insurance coverage would be required to be included in an employee’s gross income under Section 61(a)(1)3.

There are three specific scenarios that could give rise to inclusion of the receipt of employer-provided health benefits in an employee’s gross income: (1) the receipt of employer-provided coverage (i.e., employer-paid premiums); (2) the receipt of benefits paid to or on behalf of an employee attributable to medical care received by the employee, the employee’s spouse, or a dependent of the employee (i.e., medical expense payment/reimbursement); and (3) the receipt of benefits from the employer (i.e., short-term and long-term disability payments).

Section 106(a) excludes from the gross income of an employee the value of employer-provided coverage under an accident or health plan. An “accident or health plan” is an arrangement for the payment of amounts to employees, employees’ spouses, and employees’ dependents in the event of personal injuries or sickness4.

An employer’s payment of all or a portion of an employee’s health insurance premiums or the contribution of an amount to a trust or a fund to be used specifically for reimbursement of the cost of accident and health benefits5 is excluded from gross income pursuant to Section 106(a).

Section 105(a) provides that, “except as otherwise provided,” amounts received by an employee from accident or health insurance for personal injuries or sickness are taxable if paid by the employer or are attributable to employer contributions that have not been included in the gross income of the employee.

Section 105(b), however, provides that gross income does not include amounts referred to in Section 105(a) if those amounts are paid, directly or indirectly, to the employee to reimburse the employee for expenses incurred for the medical care of the employee, the employee’s spouse, or a dependent of the employee. Any medical expense claimed as a Section 213 itemized deduction cannot be excluded pursuant to Section 105.

There lies much confusion between the seemingly small differences between 105(a) and 105(b) but, essentially, the exclusion from gross income is allowed for the reimbursement of medical expenses that have already been paid by the employee and not for an employer’s direct payment of those expenses.

Section 104 excludes from gross income amounts received by an employee from accident or health insurance that the employee either paid for directly or are attributable to employer contributions that were includible in the employee’s gross income. Section 104 excludes the receipt of short-term and/or long-term disability benefits by an employee if: (1) the employer-paid premiums were included in the employee’s gross income; or (2) the employee-paid the premiums using after-tax dollars. Thus, if short or long-term disability benefits are paid with after-tax dollars, the benefit received is not included in that employee’s gross income.

As most know, federal law does not recognize domestic partnerships (or any other form of non-married partnership, such as civil unions) even if recognized by an individual state or jurisdiction of the United States. The result of this non-recognition is the loss of the exclusions from gross income contained in Sections 104, 105, and 106 for the domestic partner. These exclusions apply solely to the receipt of coverage/ benefits by an employee attributable to such employee, the employee’s spouse, and the employee’s dependents. Section 7 of Title 1 of the United States Code defines “marriage” as the legal union between one man and one woman as husband and wife and defines “spouse” as a person of the opposite sex who is a husband or a wife (emphasis added). Domestic partners (whether same-sex or opposite-sex) do not “qualify” as a spouse under federal law.

Tax Treatment of Benefits for Domestic Partners

Federal law does not extend the exclusions from gross income described above to benefits received by the employee from his/her employer for the benefit of his/her domestic partner. The typical choice an employee must make is whether to provide the benefit to his/her domestic partner (assuming the employer allows domestic partner benefits) and include the value of those benefits in the employee’s gross income or not provide benefits to the domestic partner. However, there may be more choices that are being overlooked.

The issue of employer-provided benefits for unmarried couples in general has been addressed by the IRS in several private letter rulings. If the employee’s jurisdiction or residence recognizes common-law marriage, an opposite-sex domestic partnership can qualify as common-law spouses if the requirements of their jurisdiction are met. This is not available as an option in Maryland as common-law marriage is not recognized.

Opposite-sex domestic partners may be able to qualify for the exclusions as well by seeking dependent treatment of the other partner pursuant to Section 152. The IRS has recognized in a private letter ruling that, if the requirements of Section 152 are met and the partnership is not in violation of local law, a domestic partner can be treated as a dependent.

According to Section 152, a dependent is an individual who: (1) is considered a “qualifying relative” of the employee and has gross income for the taxable year less than the exemption amount of Section 151(d); (2) receives over one-half of his/her support from the employee; (3) has the same principal residence as the employee; and (4) is a member of the employee’s household for the entire taxable year of the employee. State and local law determines whether or not domestic partners can be considered “a member of a household.” Qualification as a dependent will then extend to the children of the domestic partner as well (assuming the children meet the other requirements of Section 152).

In 2008, legislation was introduced in Maryland giving to domestic partners visitation rights in hospitals and the right to make health care decisions for his/her domestic partner where a properly executed advance medical directive is not in place. This bill, which was approved by Governor O’Malley on May 22, 2008, as Chapter 590, contained a definition of a domestic partnership.

Section 6-101(a) of the Health–Gen. Article of the Maryland Code defines “domestic partnership” as “a relationship between two individuals who: (1) are at least 18 years old; (2) are not related to each other by blood or marriage within four degrees of consanguinity under civil law rules; (3) are not married or in a civil union or domestic partnership with another individual; and (4) agree to be in a relationship of mutual interdependence in which each individual contributes to the maintenance and support of the other individual and the relationship, even if both individuals are not required to contribute equally to the relationship.”

The domestic partner of an employee who is a Maryland resident is more likely to qualify as a dependent (assuming all other requirements are met) because of this newly enacted provision. If that is the case, the value of the employer-provided benefits received by the domestic partner of such employee will be excludible from the employee’s gross income.

Conclusion

Many employers in Maryland (and throughout the United States) view providing domestic partner benefits as a way to entice new employees and retain old ones. Purchasing private health insurance can be expensive and is frequently denied if the individual seeking the benefit has a preexisting condition. Employer-provided coverage is typically much cheaper and the Health Insurance Portability and Accountability Act of 1996 (“HIPAA”) imposes strict rules regarding preexisting conditions.

With the legal recognition of “domestic partnerships” in Maryland, it is likely that a domestic partner could qualify as a dependent. That being said, if the employee’s domestic partner meets the qualifications of Section 152, the benefits provided to the domestic partner would be excludible from gross income pursuant to Section 104, 105 or 106. If the domestic partner does not qualify as a dependent, a fully informed employee may still choose to have his/her domestic partner participate in employer-provided health insurance even with the added income tax burden to the employee.

An employer trying to determine whether to provide these benefits to its employees can rest assured knowing that the cost of providing benefits to the domestic partner benefits will likely qualify for the Section 162 deduction as an ordinary and necessary business expense.

Footnotes

1For purposes of employer-provided benefits, including health insurance coverage, an employee” is a common-law employee, including inactive employees, retired employees, former employees, laid-off employees, and employees on leaves of absence. Sole proprietors, partners, LLC members and shareholders in an S Corporation owning more than a 2% interest in the corporation are not employees.

2As defined in Section 152 of the Internal Revenue Code of 1986, as amended.

3Section 61(a)(1) defines “gross income” as “all income from whatever source derived, including… compensation for services, including fees, commissions, fringe benefits, and similar items.”

4 See Section 105(e).

5See Treasury Reg. Section 1.106-1.

6 28 U.S.C.A. Section 1738C.

7 See PLRs 9603011, 9431017, 9231062, 9109060, and 9034048; See also PLR 200108010 allowing exclusion from gross income of benefits to employee’s domestic partner received from a voluntary employees’ beneficiary association (VEBA).

8 PLR 200339001.

9 Section 152(d).

10 The current personal exemption is $3,650 and is subject to phase-out.

11 See Section 152(d) and Treasury Reg. Section 1.152-1(b).

12 See Section 152(f)(3)

13 Senate Bill 566 of 2008.