Employers, Domestic Partnerships, and the IRS
Tax and Coverage Rules
When it comes to health benefits for domestic partners, employers often struggle with the tax and coverage rules. Multiple factors compound the complexity, so if you’re not an expert, it’s easy to spin in circles.
This blog is intended to provide employers with a simple overview of the landscape, so you can start to get your footing. For your specific questions or scenarios, we encourage you to talk to your tax advisor, in-house counsel or a benefits consultant at Lumity.
The information provided here does not constitute tax advice—always encourage your employees to consult with a tax professional.
There isn’t one standard definition of “domestic partner.”
Domestic partners may be same- or opposite-sex relationships. A couple typically achieves domestic partner status in one of two ways:
- Registers with a state or locality
- For Registered Domestic Partners (RDPs), fully insured employers are required to provide domestic partner coverage
- Employers must treat RDPs in the same manner as spouses when verifying status
- Meets your company’s policy for domestic partner status
- Employers can voluntarily choose to provide coverage to domestic partners
- A broader definition may be leveraged to recruit and retain employees
- Employee self-certifies using a typical affidavit approach
- Insurance carriers typically defer to a company’s definition
Compliance requirements can vary at the local, state, and federal level.
For example, in California, a registered domestic partner (RDP) has all the same rights and obligations as a spouse, and every fully insured plan must offer an RDP the same benefits as a spouse.
States with Comparable Laws
|Registered Domestic Partners (RDPs)||Civil Unions|
Arcane fun fact: Some states require that at least 1 partner is 62 years old for opposite-sex domestic partners. For instance, Washington has this age requirement for opposite-sex partners. Why? It’s generally understood as a way to provide all the state rights of marriage—without giving up the ability to claim Social Security benefits based on the work records of an ex-spouse.
Registered Domestic Partners are not spouses for federal tax purposes.
Registered Domestic Partners (RDPs) cannot file joint federal returns, and the employee receiving benefits for a partner may have to pay federal income tax on the value of the benefit, known as “imputed income.”
Two adverse tax consequences:
- After-tax payment (employee-share of the premium), and
- Federal imputed income (employer-share of the premium)
RDP status avoids imputed income at the state level, but not at the federal level. Tax-dependent status avoids both the adverse tax consequences. It’s important to make sure your payroll setup is correct.
Unless an exclusion applies, compensation is generally taxable:
- The IRS considers health coverage for a domestic partner a taxable fringe benefit that must be included in the employee’s gross income.
- The employee must receive imputed income for the employer-share of the premium paid for the domestic partner’s coverage.
- It is subject to withholding and payroll taxes and must be reported as income on the employee’s Form W-2 (similar to wages).
- The employer must determine the fair market value (FMV) of coverage.
How to Determine the Fair Market Value of Coverage
There is no IRS guidance for computing the fair market value (FMV), but employers typically take one of two approaches:
- Use the COBRA rate
- Use the plan’s COBRA premium, reduced by the 2% administrative fee, for coverage.
- This is based on self-only coverage for the domestic partner.
- If domestic partner’s non-tax dependent also need to be included, the FMV is based on employee-plus-one or family coverage (as applicable)
- Determine the Incremental Cost
- Use the incremental cost of adding coverage for one individual to the plan.
- For example, if the premium for self-only is $300 and the premium for employee-plus-one is $450, the FMV for the domestic partner is $150
4 Fair Market Value Considerations
When an employee enrolls a domestic partner in an employer’s medical, dental or vision benefit, there are four components to consider.
Fair market value (FMV) of the employee contribution to premium attributable to:
1. Employee coverage is deducted as pre-tax under Section 125 Cafeteria Plan
2. Domestic partner coverage is deducted as an after-tax deduction--unless the partner meets the IRS criteria for a qualifying relative under Code §152, as modified by §105(b).
FMV of employer contribution to premium attributable to:
3. Employee coverage is excluded from income as per Internal Revenue Code §61
4. Domestic partner coverage is added to employee gross income and is subject to all taxes just like regular wages because it is considered a fringe benefit by IRS--unless the partner meets the criteria for a qualifying relative under Code §152, as modified by §105(b).
What about the children?
A domestic partner’s child may not be the employee’s child. This means an employer might have an imputed income issue for the child as well, with the same adverse tax consequences. However, child status avoids the adverse tax consequences.
- “Child” includes natural children, stepchildren, adopted children, and foster children
- If children of a Registered Domestic Partner are considered stepchildren by the state, then the federal government mirrors this treatment
For health purposes, the IRS allows a domestic partner to be an employee’s “qualifying relative.”
If the domestic partner is a qualifying relative, the employee does not pay income tax on the value of the benefit.
- Employees are responsible for reporting if a domestic partner is a qualifying relative for tax purposes.
- The IRS allows employers to rely on the certification of the employee regarding the dependent status of their partner
The definition of “qualifying relative” is not as strict as “tax dependent” because the Gross Income Test does not apply. For reference, see Internal Revenue Code §152, as modified by §105(b). The domestic partner is a qualifying relative if he or she:
- Is not a qualifying child of any taxpayer
- Is a citizen, national, or legal resident of the U.S. or a resident of a contiguous country
- Is a member of the employee’s household for the full tax year
- Receives more than half of his or her support from the employee
In summary, it’s complicated.
Domestic partner coverage is tough to navigate. There are so many paths and turns and rabbit holes. And this is just the 101 basics—we haven’t broached COBRA coverage, account-based health plans, or your section 125 cafeteria plan.
Lumity has built its business on taking on the complexity on your behalf. From your perspective, benefits should simply work. Contact us today to discuss your business needs and determine whether we can be an advocate for you—and your employees.