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Taxation of Domestic Partner Benefits

The information in this document does not constitute legal advice. For assistance with legal questions specific to your situation, please consult an attorney.

When employees elect health insurance coverage from their employers for their families, the majority of their employers contribute to at least half of the insurance coverage's cost. For employees with different-sex spouses, federal and state tax law do not require employers to report their contribution to the employee's or the employee's different-sex spouse as taxable wages earned — the value of the health insurance coverage can be excluded from the employee's gross income.

Non-dependent same-sex partners and spouses (and their dependents) are treated differently under federal and most states' tax laws:

  • Imputed income: the estimated value of the employer's financial contribution towards health insurance coverage for non-dependent same-sex partners must be reported as taxable wages earned.
    • Employees: This tax penalty, depending on the individual and the estimated value of the health benefit, can be in the thousands of dollars per year and can result in the individual paying upwards of 50% more in federal taxes. As of 2007, employees with partner benefits pay on average $1,069 per year more in taxes than would an employee with the same coverage for a different-sex spouse. See the Williams Institute and Center for American Progress report: Unequal Taxes on Equal Benefits
    • Employers: Because the imputed income increases the employee's overall taxable income, it also increases the employer's payroll taxes — the federal Social Security (FICA) and unemployment insurance tax (FUTA) that employers pay based on employees' taxable incomes. According to the same CAP/Williams Institute report,employers collectively pay a total of $57 million per year in additional payroll taxes because of this unequal tax treatment. Employers also face additionaladministrative burdens of annually tracking the dependent status of covered same-sex partners and spouses and maintaining separate payroll functions for income tax withholding and payroll taxes.
  • Pre-tax dollars may not be used to pay for the partner's coverage, limiting the use of Flexible Spending Accounts (FSAs), Health Reimbursement Accounts (HRAs) and Health Savings Accounts (HSAs).

See: Federal laws impacting domestic partner benefits.

Federal Legislation: Tax Equity for Health Plan Beneficiaries Act

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 non-dependent domestic partner. HRC recruits businesses to join the Business Coalition for Benefits Tax Equity in support of this legislation.

Calculating imputed income: how and when?

Employers that offer health insurance benefits to same-sex partners and spouses of their employees must track dependent status of unmarried partners and different-sex spouses or otherwise allow their employees to certify that their partner or spouse is a dependent for that tax year.

If employers provide health insurance to beneficiaries other than a tax dependent as defined by the IRS, such as a non-dependent domestic partner, the employer must calculate the estimated fair market value of those health benefits and charge that amount to the employee as "imputed income" on the employee's Form W-2.

The IRS has provided little guidance as to how employers should calculate the fair market value of coverage. The method employers use varies depending on the employer and the type of coverage it provides.

  • The employer can calculate the difference between the amount an employer would contribute for the employee alone and the amount the employer would contribute for a couple or family. Generally, this is more straightforward for employers that obtain insurance coverage through a third party (know as "fully-insured" or "insured" employer plans), where the employer can base their calculations on "active coverage" rates that the insurance company charges.
  • Employers can also calculate the difference between the actuarial value of insurance for a single person and insurance for a couple or family. Employers that fund and pay for health insurance on their own (known as "self-insured" employer plans that are typically administered or managed by a third-party) base their calculations on COBRA coverage rates, since the active coverage rates are less easily known.

Employers should ensure as fair and accurate a method as possible.

In recent years, some employers have begun "grossing up" employees' income to offset the imputed income tax from partner benefits.

Tax Example

If an employee makes $32,000 each year, and the employee's non-dependent 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.

 

Calculation of imputed income and tax liability for non-dependent domestic partner health insurance coverage:
  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