We are seeing an increasing number of employers paying health insurance premiums for the domestic partners of employees. Before implementing this type of program, employers need to be aware of the tax consequences for the employees.

This issue was brought to us by one of our clients. The client pays health insurance premiums for its employees, their spouses, their dependents, and domestic partners. Our client wanted to know if the payment of premiums for a domestic partner would be taxed to the employee for federal income tax purposes.

First and foremost, the value of employer provided health plan coverage for employees, employee’s spouses, and dependents is excluded from the employee’s gross income under §106 of the Internal Revenue Code. A domestic partner is not considered a “spouse” as a result of The Defense of Marriage Act. The Defense of Marriage Act defines spouse as “only to a person of the opposite sex who is a husband or wife.”

In order for the premiums for domestic partners to be excluded from the employee’s gross income, the domestic partners must satisfy the definition of a “dependent” under Code §152. Section 152 defines a dependent as a “qualifying child” or a “qualifying relative.”

A “qualifying child” is (1) a child, descendant of the child, brother, sister, stepbrother or stepsister or descendant; (2) who has the same principle place of residence for more than one-half of the taxable year; (3) who is not over 19 (or 24 for students) by the end of the calendar year; and (4) the qualifying child has not provided over one-half of his or her support for the calendar year. A domestic partner would not satisfy the definition of a “qualifying child.”

Therefore, a domestic partner must fall within the definition of a “qualifying relative.” A “qualifying relative” is an individual who (1) has a relationship with the taxpayer that is not void by local law; (2) whose income must be less than the exemption amount as defined in Code §151(d) (which is currently $2,000); (3) who is a family member or has the same residence as the employee; and (4) who receives at least one-half of his or her support from the employee. The problem with satisfying the definition of “qualifying relative” is not the income restrictions placed upon the domestic partner, but the first requirement: whether the relationship of the taxpayer is illegal under local law. However, in 2003, the U.S. Supreme Court struck down state criminal laws regarding private consensual sexual activity. This placed doubt on whether the first requirement is enforceable.

We advised our client that, if they decide to pay the premiums for domestic partners, they have two options. The first option is to pay the premiums for the domestic partner and to include the fair market value of the coverage in the employee’s taxable income. The second is to pay the premiums for the domestic partner, but not include the fair market value of coverage in the employee’s income. In that case, the employer should obtain affidavits or certifications from the employee regarding the dependency status of the domestic partners.

Note: Employers should also consider the impact of state income tax laws. We have researched the tax laws of various states and found that they vary significantly.
Source: The Report to Plan Sponsor