Legal Bulletins

Employers are increasingly considering offering health benefits to their employees' domestic partners. Employers who offer such benefits must make plan design decisions. In addition, employees and employees should be aware of the tax implications of domestic partner health coverage.

Tax Issues. If a domestic partner is an employee's "dependent" under the Internal Revenue Code, the cost of health coverage and the value of any benefits received are tax free. Generally, a domestic partner is considered a dependent under Section 152 (a)(9) of the Internal Revenue Code if the domestic partner resides in the household of the employee and receives over half of his or her support from the employee. In order to establish that a domestic partner is a dependent, an employer could require that a participant either provide his or her prior year's Form 1040 reflecting that the domestic partner has been claimed as a dependent or certify in writing that the domestic partner qualifies as a dependent under the Internal Revenue Code. The IRS has approved these methods in Private Letter Ruling 200108010. Some employers do not want the responsibility of determining whether a domestic partner qualifies as a dependent, and simply consider all domestic partners non-dependents.

If a domestic partner does not qualify as a dependent, the cost of the domestic partner's health coverage cannot be provided tax free. An employee must pay for the coverage for a non-dependent domestic partner with after-tax employee payments and/or the fair market value of employer provided coverage must be included in the employee's gross income. If an employer fails to include in the income of an employee the cost of health coverage which it provides for a non-dependent domestic partner (or wrongfully permits the employee to purchase health coverage for the domestic partner on a pre-tax basis), it is possible that the IRS could seek to tax the value of any health benefits actually received - which could dwarf the cost of the coverage.

If the employer pays for any portion of the non-dependent domestic partner's coverage, the excess of the fair market value of the coverage provided for the domestic partner over the amount paid by the employee for that coverage must be included in the employee's income and constitutes wages for FICA, FUTA, and withholding purposes.

For example, assume that the full premium for employee only coverage is $175 per month but an employee is only required to pay $35 per month, and the full premium for employee and spouse/domestic partner coverage is $400 per month but an employee is only required to pay $115 per month, with the employer picking up the rest of the premium cost for each type of coverage. This means the employee pays $80 per month over the cost of employee only coverage for the spouse/domestic partner coverage ($115-$35). The excess fair market-value of spouse/domestic partner coverage is $225 per month ($400-$175). Because the employee paid less than the fair market value of the additional coverage, the employee will be taxed on the difference between the excess fair market value of the coverage ($225) and the amount paid for it ($80). This generates $145 per month of taxable income to the employee when the coverage is for a non-dependent domestic partner ($225-$80).

Many employers allow employees to pay for health coverage on a pre-tax basis through a Section 125 plan. However, Section 125 plans may only be used to pay for benefits which may be provided tax free. Because domestic partner coverage for a non-dependent cannot be provided tax free, an employee may not pay for a domestic partner's health benefits on a pre-tax free basis through a Section 125 plan. Similarly, an employee may not use a flexible spending account (which allows employees to receive reimbursements for expenses not covered by a health plan - such as prescription eyeglasses, co-payments and deductibles) for a non-dependent domestic partner.

Design Issues. Employers may define a domestic partner as they choose and do not have to limit domestic partners to those who qualify as dependents. Common eligibility requirements for coverage of a domestic partner include a minimum period during which the employee and the domestic partner have resided together, a requirement that both the employee and the domestic partner be unmarried, and a requirement that the employee and the domestic partner not be blood relatives. Some employers limit domestic partner benefits to same sex relationships and/or require documentation of financial interdependence (e.g., joint lease, joint bank account). Some municipal governments permit domestic partners to register their relationships and some employers require evidence of registration if it is available. Most employers require employees and their domestic partners to sign an affidavit attesting to the satisfaction of the eligibility conditions imposed.

While COBRA requires most employers to offer continued health coverage in the event that coverage is terminated due to certain events such as termination of employment, death and divorce, employers do not have to offer COBRA continuation coverage to non-dependent domestic partners. However, an employer may structure continued health coverage as it chooses, and may choose to offer COBRA continuation coverage to non-dependent domestic partners.

Before granting health benefits to non-dependent domestic partners, employers with insured health plans should verify that their insurance policies cover domestic partners and employers with self funded health plans should verify that any stop loss policy which they have covers domestic partners.