Taxation of Domestic Partner Benefits
When an employer provides health insurance for the spouse or dependents of an employee, federal tax law allows the value of the health insurance coverage to be excluded from the employee’s gross income.
But when an employer provides the same health insurance coverage for the domestic partner or the dependents of the domestic partner of an employee, federal tax law considers the fair market value of that coverage, including the employee's pre-tax contributions, as "imputed income" to the employee. According to a December 2007 report by the Center for American Progress and the Williams Institute, employees with partner health benefits now pay on average $1,069 per year more in taxes than would a married employee with the same coverage. The only exception is when a domestic partner qualifies as a dependent of the employee under IRS definitions.
Additionally, employees cannot use pre-tax dollars to pay for a domestic partner's coverage, precluding them from the full benefits of a Flexible Spending Account, Health Reimbursement Account or Health Savings Account.
Because the imputed income increases the employee's overall taxable income, it also increases the employer’s payroll taxes - the Social Security and unemployment insurance tax that employers pay based on employees’ taxable incomes. According to the same CAP/Williams Institute report, employers pay a total of $57 million per year in additional payroll taxes because of this unequal tax treatment.
As a result, gay, lesbian, bisexual and transgender individuals that secure employer-provided health insurance coverage for themselves and their unmarried partners face a significant tax penalty; one that, depending on the individual, can be in the thousands of dollars per year and result in the individual paying upwards of 50% more in federal taxes. Meanwhile, employers that extend partner health benefits pay higher payroll taxes and face the administrative burden of maintaining separate payroll functions for income tax withholding and payroll taxes.
Federal Legislation
The Human Rights Campaign advocates that the federal government end the taxation of health benefits provided by employers to any beneficiary covered under an employee’s benefits plan, including a domestic partner. HRC recruits businesses to join the Business Coalition for Benefits Tax Equity in support of this legislation.
- Tax Equity for Health Plan Beneficiaries Act
- Businesses support the Tax Equity for Health Plan Beneficiaries Act
How and when do employers calculate imputed income?
If employers provide health insurance to beneficiaries other than a tax dependent as defined by the IRS — in essence, unmarried domestic partners who are not primarily supported by their partner’s income — the employer must calculate the estimated fair market value of those health benefits and charge that to the employee as "imputed income."- Employers Still Struggle to Determine Imputed Income for Domestic Partner Benefits: Calculating Fair Market Value of Coverage (PDF) [mwe.com]
Tax Example
If an employee makes $32,000 each year, and the employee’s partner’s insurance is valued at $907 per month, the employee’s tax liability for the year will be $4,710. However, an employee covering his or her opposite-sex spouse in the same situation would have a tax liability of only $3,155. This represents nearly a 50 percent increase in tax liability.
| Single Employee | Employee with Spouse | Employee with Domestic Partner | |
|---|---|---|---|
| Annual Employee Salary | $ 32,000 | $ 32,000 | $ 32,000 |
| Monthly Employer Contributions for Benefits |
335 | 907 | 907 |
| Annualized Employer Contributions for Benefits |
4,020 | 10,884 | 10,884 |
| Imputed Income | - | - | 6,864 (10,884 - 4,020) |
| Taxable Income | 32,000 | 32,000 | 38,864 |
| Employee's 2006 Tax Liability | 3,155 | 3,155 | 4,710 |
Exceptions
When the employee's domestic partner is a qualifying dependent
If the employee's domestic partner is a qualifying dependent under IRS definitions, the value of the health insurance coverage can be excluded for federal tax purposes. Employers should allow their employees to certify that their partner does indeed qualify and treat contributions for that coverage in the same manner as spousal coverage. Employers and employees not already taking advantage of this opportunity should consult a tax attorney.
When the employee's domestic partner is recognized by the state
The federal definition of spouse is limited by the Defense of Marriage Act of 1996, which renders invalid most state or local tax provisions for gay, lesbian, bisexual and transgender families for the purpose of federal taxes. Both employers and employees may have to calculate multiple iterations of payroll and income taxes for employees in these states.
What Employers Can Do
Until federal law changes, employers will be required to charge the imputed value of domestic partner benefits to employees with domestic partners that are not qualifying dependents. Employers should join the Business Coalition for Benefits Tax Equity that supports federal legislation to end this disparity. Some have considered grossing up affected employees' wages to offset the tax burden.
What other federally-defined employment benefits are denied to domestic partners?
