The exclusion for dependents’ health coverage is of limited value, however, because most civil union partners do not qualify as dependents. (To be an employee’s dependent, the civil union partner must, among other things, receive over one-half of his or her support for the year from the employee.) The bottom line is that, in most cases, the monetary value of a civil union partner’s coverage (net of any after-tax contributions an employee has made for it) is an item of taxable income to the employee.
How an employer determines the value of a civil union partner’s coverage is not clearly set out by the IRS. However, a review of various rulings and notices leads many experts to conclude that the best measure of the value is the underlying cost of the coverage. A proxy for that cost would be the COBRA premium for that benefit (less the two percent administrative fee). If the employee pays any of that cost with after-tax funds, that amount would be deducted from the taxable value. If an employee pays for civil union partner benefits through a cafeteria plan (which permits the employee to exclude the amounts paid for coverage from taxable income) those amounts are considered to be employer contributions to the plan and taxable to the employee to the extent that they pay for civil union partner coverage. Put another way, cafeteria plan amounts are not deducted from the value of the civil union partner’s coverage when making the determination of how much to include in the employee’s taxable income. (See Willis’ Employee Benefits Aler , Issue 63,“Taxation of Benefits for Domestic Partners,” for a detailed discussion of the determination of the taxable portion of the benefits provided for a domestic partner.)
The bottom line is that, in most cases, the monetary value of a civil union partner’s coverage (net of any after-tax contributions an employee has made for it) is an item of taxable income to the employee. [However] how an employer determines the value of a civil union partner’s coverage is not clearly set out by the IRS.
State Tax Implications
State income tax laws add another piece of administrative complexity because they do not always work the same way that federal income tax laws work. For example, under the New Jersey spousal parity rules, the health benefits provided to an employee’s civil union partner generally are not taxable (that is, they are treated the same way for state taxes that benefits for married couples would be treated). This means that an employer must adjust its payroll system so that civil union partner coverage is treated as taxable for purposes of federal withholding and payroll taxes and is treated as non-taxable for New Jersey’s withholding and payroll taxes.
An odd New Jersey law creates further confusion. Under that law, amounts that are subject to an employee’s election under a cafeteria plan are considered to be taxable wages for New Jersey state income tax purposes, no matter whose coverage is purchased with those amounts. That rule must be taken into account for any portion of a civil union partner’s coverage that is paid for through a cafeteria plan. (Of course, this tax rule is the same for spouses and parties to a civil union.)
State laws and federal laws paint a picture of a society in conflict over the rights and responsibilities that should be accorded to same-sex partners. Perhaps it should come as no surprise that benefits administrators will have their hands full keeping up with the sometimes conflicting requirements. Employers that operate in several states will have a particularly difficult time.
Willis North America • 08/07