Many employers have extended health care benefits to domestic partners of employees or are considering such an extension. Until recently, the tax treatment of such benefits has been uncertain. The Internal Revenue Service has recently issued guidance on the tax treatment of benefits for domestic partners. If a domestic partner qualifies as a “dependent” under the Internal Revenue Code, medical and dental benefits provided on behalf of the domestic partner will not be included in the associated employee’s wages for the purpose of calculating federal income and employment taxes. This is big news for gay couples, and employers should be aware of how their work force may be affected by it.
Health coverage for an employee, the employee’s spouse and dependents is specifically excluded from the employee’s gross income. The U.S. Congress recently passed the Defense of Marriage Act, which says that same-sex domestic partners are not treated as "married" for federal tax purposes. While same-sex domestic partners do not qualify as "spouses" for federal tax purposes, they might qualify as "dependents" if they meet the requirements specified in the Internal Revenue Code.
The Internal Revenue Code contains two different definitions of a dependent. Under the relevant definition here, an individual who received more than half of his or her support for the year from the taxpayer, whose principal abode is the taxpayer’s home and who is a relative of the taxpayer or member of the taxpayer’s family during the taxable year of the taxpayer, is a "dependent". IRC § 152(a)(9). However, an individual is not considered a member of a taxpayer’s family if the relationship between the taxpayer and the individual is in violation of local law. IRC § 152(b)(5). Thus, in states where gay partnerships are legal, both same-sex and opposite-sex domestic partners can qualify as "dependents" under the Internal Revenue Code.
These requirements can be illustrated with the following examples.
- John is employed at Company and rents an apartment. Jane works part-time at various odd jobs. A close relationship forms between them and Jane moves in with John on January 1, 2003, living with him in his apartment for the entire year. John pays the rent and all other monthly bills. When she has money, Jane contributes to the cost of food. However, John pays for the majority of her daily living expenses. Because Jane receives more than half her support from John, resides in John’s home and is a member of his household, she is John’s "dependent" for federal tax purposes.
- Frank is employed at Company and owns his own home. Bob works part-time at various odd jobs. A close relationship forms between them and Bob moves in with Frank on January 1, 2003, living with him in his home for the entire year. Frank pays the mortgage and all other monthly bills. When he has money, Bob contributes to the cost of household expenses. However, Frank pays for the majority of Bob’s daily living expenses. Bob receives more than half his support from Frank, resides in Frank's home and is a member of his household. Therefore, if his relationship with Frank is not prohibited by local law, he is Frank's "dependent" in 2003 for federal tax purposes.
- Marsha is employed at Company and owns her own home. To reduce her expenses, Marsha offers to let Susan, a close and long-time friend, rent a room in her house. Susan moves in on January 1, 2003 and lives in Marsha's house for the entire year. Susan makes monthly rental payments throughout the year and pays for her own incidental living expenses. Although Susan's principal abode is Marsha's home, she provides more than half of her own support and is not a member of Marsha's household. Therefore, she does not qualify as Marsha's "dependent" for federal tax purposes.
- Craig is employed at Company and owns his own home. Craig's father moves into his house on January 1, 2003. During 2003, Craig's father receives small monthly Social Security payments. He has no other income and few assets. He does not pay rent, nor contribute to household expenses. The majority of his medical bills are paid through Medicare. Because Craig's father receives more than half his support from Craig, has his abode in Craig's home, is a relative and is a member of Craig's household, he is Craig's "dependent" in 2003 for federal tax purposes.
If the domestic partner of an employee qualifies as a "dependent," medical and dental coverage and reimbursements provided to the domestic partner will be excludable from the employee’s gross income for both federal income and employment tax purposes. Conversely, if a domestic partner does not qualify as a "dependent", the excess of the coverage's fair market value over the cost to the employee, is added to the employee’s gross income and is included as taxable wages.
To ensure that medical and dental benefits are treated appropriately, employers are advised to annually require verification that an employee’s domestic partner qualifies as a "dependent." Such a verification can consist of an annual certification signed by the employee and the domestic partner that the domestic partner meets the support and relationship tests. Employers may wish to consult with appropriate legal counsel on meeting the requirements discussed here. Specific cases are sure to test the definitions outlined by the IRS as couples come forward seeking more beneficial tax calculations from their employers.
Beth L. Fowler is an associate at the McLane, Graf, Raulerson & Middleton law firm handling individual and business tax issues under both federal and state law, and represents taxpayers before the Internal Revenue Service and the New Hampshire Department of Revenue Administration. She can be reached directly (603) 628-1259 or by email at [email protected].