(Editor's note: This article is Part II in a series of two articles
covering the basics of domestic partnership benefits. In the first
article, we discussed the definitions and practical considerations of addressing
the issue of domestic partnerships. In this one, we address the legal implications.)
By SUSAN E. SCHOENFELD, J.D.
Legal Editor, Business & Legal Reports
If you are considering offering domestic partnership benefits, what are the
legal requirements? How does the Internal Revenue Service (IRS) treat benefits
to a domestic partner and what requirements does the employer have to meet?
Is income subject to withholding for federal FICA (Federal Insurance Contributions
Act) and FUTA (Federal Unemployment Tax Act)? What about health insurance and
the Consolidated Omnibus Budget and Reconciliation Act (COBRA)?
Although certain states recognize some form of domestic partnerships and have
their own requirements, there are some general guidelines to consider when formulating
your policy on domestic partnerships and benefits. (Note: An organization should
always consult with a lawyer, as well as its insurance company, before offering
benefits to domestic partners):
Tax treatment and dependency status
As you may already know, married employees pay no taxes on healthcare benefits
that they receive for their spouses and dependents because federal tax laws
do not classify the money that is paid by the employer for these benefits as
wages. Treasury Regulation §1.106-1 provides that an employee's gross income
does not include contributions that his or her employer makes to an accident
or health plan for compensation (through insurance or otherwise) to the employee
for personal injuries or sickness of the employee, the employee's spouse, or
the employee's dependents. Therefore, the money that is paid for health benefits
for the employee's spouse and dependents that is not considered wages is excluded
from the employee's gross income (Internal Revenue Code (IRC) §§105-106).
How are domestic partners treated under the Tax Code? Employees with a domestic
partner often must pay for coverage with post-tax dollars, and then must pay
taxes on the employer's share of payment for benefits of domestic partners as
added income because domestic partners do not have status as spouses (under
the Defense of Marriage Act (DOMA), discussed in Part I of this series, or as
Qualifying as a dependent
Because a domestic partner is not considered a spouse, the tax treatment of
the domestic partner depends on whether the domestic partner is able to qualify
as the employee's dependent. Three criteria must be met for a domestic partner
to be considered a dependent (IRC §152).To be considered a dependent:
- The person must receive more than half of his or her support from the employee;
- The person must live in and be part of the employee's household; and
- The relationship must not be in violation of local law.
If the employee does qualify as a dependent under the IRC, then payments for
healthcare coverage and other benefits will be treated in the same way as coverage
for other employees with family coverage. If payment of health insurance premiums
is made through a cafeteria plan, the premiums for domestic partner coverage
may be deducted from the employee's salary on a pretax basis.
If the domestic partner does not qualify as a dependent, the value of the coverage
is included in the gross income of the employee, and the value of the coverage-not
the amount of the benefits-must be reflected on the employee'sW-2 Form.
For an employee who does not receive tax-favored status, the tax is determined
by assessing a fair market value for covering the domestic partner. The amount
is then reported on the employee'sW-2 Form and is subjected to Social Security,
FICA, FUTA, and federal withholding taxes.
Wage withholding, FICA, and FUTA
An employee who covers a domestic partner who does not qualify for dependency
status must pay taxes on that health coverage. IRS has determined that the amount
of the health coverage must be included in the gross income of the employee
because it constitutes wages under Code Section 3401(1) and Section 3121(a).The
amount of health coverage is, therefore, subject to withholding of income, FICA,
and FUTA taxes. The amounts to be withheld need to be deducted from the employee's
In order to avoid any misunderstandings about tax consequences to the employee,
many employers include a statement about tax consequences in an affidavit that
the employee is asked to sign. An example might be that: federal taxes (federal
tax, FICA, and FUTA) and state taxes are deducted for the employee's taxable
income for the cost of providing coverage for domestic partners. Additional
handouts with additional explanations are also a common practice.
Section 125 flexible benefits and spending accounts
What is the tax treatment for a domestic partner with a Section 125 flexible
benefit plan and spending account? Under a cafeteria plan or health flexible
spending account (FSA), if a domestic partner does not qualify as the employee's
dependent, the employee cannot pay premiums for coverage for that partner on
a pretax basis through the premium conversion portion of a Section 125 cafeteria
plan. The employee may not submit the domestic partner's healthcare or dependent
care expenses for pretax reimbursement from the employee's health FSA, even
if the employee paid those expenses.
Federal law denies same-sex couples coverage under COBRA for the nonemployee
same-sex spouse (29 U. S. C. §§ 1161 - 1168). Insurance companies
are covered by both state and federal regulations and, therefore, may be required
under state regulations to extend benefits to a same-sex partner. Before extending
such rights, an organization should obtain an insurance carrier's written consent.
The Employee Retirement Income Security Act (ERISA) preempts state and local
law so that a same-sex spouse is not recognized and entitled to coverage. An
employer has the option to extend ERISA to same-sex spouses and domestic partners,
however, certain spousal benefits-such as survivor and pre-retirement annuities
under pension plans and the right to death benefits under 401(k) plans-will
not be afforded to these couples pursuant to DOMA.
It is important to remember that, under ERISA, once an employer writes a definition
of domestic partner into a benefit plan, it is obligated under federal law to
follow that definition when administering the plan. Therefore, the employer
must be very careful
that the language used accurately reflects only those situations where the employer
intends to apply coverage.