EMPLOYEE BENEFITS

What Employers Need to Know About Domestic Partner Health Coverage

August 2001

By Donald R. Saxon*
For New Hampshire Business Review

In 1980, the Village Voice, a New York City weekly, became the first employer to offer health coverage to their employees' unmarried domestic partners. During the next decade, this concept remained relatively unfamiliar; fewer than two-dozen U.S. employers offered domestic partner health coverage in 1990. However, through the 90s, domestic partner coverage expanded rapidly. This year approximately 3,693 U.S. employers, including 123 of the Fortune 500, offer domestic partner health coverage. Several New Hampshire employers now offer domestic partner health coverage.

As employers make the decision to offer health coverage to their employees' domestic partners, they need to be prepared to navigate the various federal and local laws that may apply to their plans. Most significantly, employers and employees need to be aware of potential traps for the unwary.

The Tax Problem

Under Internal Revenue Code ("IRC") §106, the value of employer provided health plan coverage for employees, employee's spouses, and dependents (collectively "Qualified Dependents") is excluded from the employee's gross income. Additionally, reimbursements received under the terms of the plan are excluded from an employee's gross income to the extent that the reimbursements relate to expenses incurred for medical care of Qualified Dependents.

However, if employer provided health plan coverage is extended to any person other than a Qualified Dependent, (1) premiums representing coverage for the non-qualified person must be included in the employee's gross income pursuant to IRC §61; and (2) the plan reimbursements for the non-qualified person must be included in the employee's gross income, except to the extent the employee was previously taxed on the value of the coverage. IRC §104(a)(3).

Traditionally, the Internal Revenue Service (IRS) has deferred to state law to define the term "spouse." However, the Defense of Marriage Act provides that same sex domestic partners may not be treated as an employee's spouse for purposes of federal law. Same sex domestic partners will not be afforded the preferential tax treatment otherwise available to spouses; nor will unmarried heterosexual domestic partners. New Hampshire does not have domestic partner civil union legislation as does Vermont which officially recognizes the civil union of homosexual partners who elect to undergo a civil ceremony. However, even if statutory recognition existed, the tax benefits of Sections 106 and 104 would not be available. The IRS has addressed domestic partner benefits in several Private Letter Rulings, one of which involved a municipality which recognized and solemnized domestic partner relationships. In each case, the IRS determined that the domestic partner was not a spouse, did not qualify as a dependent under IRC §152 and, therefore, the employee was taxable on the health coverage premiums allocable to the domestic partner.

The only opportunity for domestic partner coverage to qualify for the §106 exclusion is if the domestic partner falls within the definitional ambit of "dependent" under IRC §152:

1. The domestic partner must be a member of the employee's household during the employee's entire taxable year;
    
2. The employee's home must be the domestic partner's principal place of abode;
    
3. The employee must provide over half of the domestic partner's support.

It is the third requirement that most frequently excludes domestic partners from dependent qualification. Typically, both partners are working and therefore neither is providing more than one-half of the other's support.

The tax consequences to employers and employees for failure to include a non-dependent domestic partner's health care premiums in compensation income include the following:

1. The Employee Will Have Unreported Income. If an audit results in the determination that the employee's domestic partner is receiving health care benefits pursuant to the employer's health plan and the premium allocable to that domestic partner is not reported on the employee's 1040, then the employee will have a tax deficiency for the year in which it is not included, and will have to pay additional taxes, interest and, possibly, penalties.
    
2. The Employer May Face W-2 Penalties. If the employer fails to include the premiums allocable to the domestic partner on the employee's W-2 and has therefore filed an incorrect W-2, the employer will face a penalty ranging from $15 per form to $50 per form (a maximum of $250,000).
    
3. 941 Penalties. If the employer is not including the domestic partner's portion of the insurance premium for W-2 compensation purposes, then the employer is probably not including that compensation for FICA purposes on Form 941; nor is the employer making the correct amount of payroll deposits. Penalties for failing to deposit correct employment taxes range from 2% to 5% of the underpayment; 941 underreporting results in a penalty of 5% of the unpaid tax.

The COBRA Problem

Under the Consolidated Omnibus Budget Reconciliation Act of 1985 ("COBRA"), an employee or Qualified Dependent has certain rights to continued health coverage upon the occurrence of a "qualifying event." For example, if an employee loses his job, dies or is divorced, the "qualified beneficiary" who has been covered by the employer's health plan has a right to continued coverage for 18 or 36 months depending upon the nature of the "qualifying event." However, a qualified beneficiary within the meaning of COBRA is limited to an employee, spouse or dependent child who is covered under the plan. Qualified beneficiary does not include domestic partners. Therefore, if a domestic partner should lose his/her coverage as a result of a "qualifying event," the domestic partner does not have the right to continuation of coverage. Continuity of coverage could be provided voluntarily by the employer with the cooperation of the health insurer or HMO. However, there is no federal mandate for continued coverage as there is with all other employers of 20 or more employees. Moreover, even if the employer wishes to provide domestic partner coverage voluntarily, to include COBRA rights, the insurance carrier underwriting the plan may not be willing to provide that coverage.

Actions Needed to be Taken by Employers

Employers who provide health care benefits for domestic partners typically require an affidavit by the employee and domestic partner certifying that their relationship is committed and in lieu of marriage; the relationship is monogamous; neither is married to or partnered with any other spouse, spousal equivalent or domestic partner; they have co-habitated for the required length of time; the employee does not have a spouse, ex-wife, or former domestic partner currently covered under the plan; the partners are not related by blood or adoption in a manner that would bar marriage under local law and each are responsible for the common welfare and living expenses of the other. The affidavit limits coverage to those persons committed to a long-term relationship. Unfortunately, it has no effect upon the tax and COBRA ramifications.

Employers must still take the following actions:

1. Include that portion of the premium allocable to the domestic partner in the employee's W-2 compensation unless the domestic partner meets the definition of dependent under Section 152.
    
2. Once the W-2s are accurately prepared and reported, then Form 941 must also report the total employee payroll compensation, including the share of health care premium allocated to the domestic partner.
    
3. The Summary Plan Description (SPD) issued to each beneficiary covered under the plan, should indicate that the portion of the premium allocable to domestic partner coverage is taxable income to the employee and will be included as part of W-2 compensation. The SPD and COBRA notice should provide that domestic partners are not qualified beneficiaries for COBRA purposes. Domestic partners will not have the COBRA rights accorded to qualified beneficiaries.

Should Employers Continue to Offer Domestic Partner Coverage?

Providing domestic partner health coverage is still a good idea for employers and a good policy for society. Nationally, about 19% of workers have the option of obtaining health care benefits for their domestic partners; the number of domestic partnerships is increasing. There are more unmarried couples openly cohabiting than ever before in this country's history. In the competitive employment marketplace, provision of domestic partner health benefits may help attract and retain quality employees. Moreover, even with the adverse tax consequences, the cost of the employee and domestic partner acquiring coverage through a group plan is still less expensive then acquiring coverage through an individual policy in the open market. Finally, from an overall policy perspective, regardless of one's moral, social or religious views regarding homosexuality and non-marital heterosexual co-habitation, we should encourage health coverage for as many individuals as possible. If domestic partner coverage reduces the number of persons who are without health coverage, then this is a positive result.

*Donald R. Saxon is admitted in New Hampshire, California, and Nevada.

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