Tax Equality for Health Beneficiaries

Taxation of Domestic Partner Health Benefits

Employers nationwide, from small businesses to large corporations, are choosing to offer employment benefits for unmarried domestic partners, including health insurance coverage. Employers choose to offer these benefits not just because they believe it is a matter of basic fairness, but also because offering these benefits contributes to the bottom line. A majority of Fortune 500 companies offer these benefits, along with many small businesses. Unfortunately, under current law employers who choose to offer domestic partner health benefits are punished with higher payroll taxes and administrative confusion. Employees who take advantage of these benefits are similarly punished, forcing a choice for some families between higher taxes and remaining uninsured.

Federal and state tax law do not require employers to report their coverage of an employee’s spouse as taxable wages earned — the value of the health insurance coverage is excluded from the employee’s gross income. However, employers are required to include these benefits as part of an employee’s gross income if the spouse or partner is of the same sex, or for unmarried heterosexual pairs, thus increasing the tax burden on both employer and employee. This unfair tax burden amounts to over $235 million annually.

Federal and many states’ tax laws punish employers by discriminating against same-sex partners/spouses (and their dependents). These beneficiaries are treated differently in:

Imputed income: the estimated value of the employer’s financial contribution towards health insurance coverage for non-dependent domestic partners must be reported as taxable wages.

  • Employers: Because the imputed income increases the employee’s overall taxable income, it also increases the employer’s payroll taxes — the federal Social Security (FICA) and unemployment insurance tax (FUTA) that employers pay based on employees’ taxable incomes. Employers collectively pay a total of $57 million per year in additional payroll taxes because of this unequal tax treatment. Employers also face additional administrative burdens of annually tracking the dependent status of covered same-sex partners and spouses and maintaining separate payroll functions for income tax withholding and payroll taxes.
  • Employees: This tax penalty, depending on the individual and the estimated value of the health benefit, can be in the thousands of dollars per year and can result in the individual paying upwards of 50 percent more in federal taxes. As of 2007, employees with partner benefits pay on average $1,069 per year more in taxes than would an employee with the same coverage for a different-sex spouse.

Pre-tax dollars may not be used to pay for the partner’s coverage, limiting the use of Flexible Spending Accounts (FSAs), Health Reimbursement Accounts (HRAs) and Health Savings Accounts (HSAs).

 

Federal Legislation: Tax Equity for Health Plan Beneficiaries Act

Log Cabin Republicans advocate that the federal government end the taxation of health benefits provided by employers to any beneficiary covered under an employee’s benefits plan, including a non-dependent domestic partner.  This would equalize treatment of same- and opposite-sex partners and end the penalty imposed on businesses which have elected to treat their employees equally for purposes of health benefits.

The Tax Equity for Health Plan Beneficiaries Act cuts businesses’ administrative burdens

If employers provide health insurance to beneficiaries other than a tax dependent as defined by the IRS, such as a non-dependent domestic partner, the employer must calculate the estimated fair market value of those health benefits and charge that amount to the employee as “imputed income” on the employee’s Form W-2.

The IRS has provided little guidance as to how employers should calculate the fair market value of coverage, contributing to confusion and uncertainty among the business community. The method employers use varies depending on the employer and the type of coverage it provides. 

  • The employer can calculate the difference between the amount an employer would contribute for the employee alone and the amount the employer would contribute for a couple or family. Generally, this is more straightforward for employers that obtain insurance coverage through a third party (known as “fully-insured” or “insured” employer plans), where the employer can base their calculations on “active coverage” rates that the insurance company charges.

  • Employers can also calculate the difference between the actuarial value of insurance for a single person and insurance for a couple or family. Employers that fund and pay for health insurance on their own (known as “self-insured” employer plans that are typically administered or managed by a third-party) base their calculations on COBRA coverage rates, since the active coverage rates are less easily known.

Employers bear the burden of utilizing as fair and accurate a method as possible. The challenge is exacerbated by the fact that pre-tax dollars cannot be used to pay for a partner’s coverage.

In recent years, some employers have begun “grossing up” employees’ income to offset the imputed income tax from partner benefits – essentially paying these employees more in order to equalize their actual take-home compensation. While this effort is laudable, the better solution is for government to remove the unfair tax burden, thus leaving businesses free to invest those funds in new hiring or production.

Tax Example

If an employee makes $32,000 each year, and the employee’s non-dependent partner’s insurance is valued at $907 per month, the employee’s tax liability for the year will be $4,710. However, an employee covering his or her opposite-sex spouse in the same situation would have a tax liability of only $3,155. This represents nearly a 50 percent increase in tax liability.

 

Chart: Equal Benefits, Un-Equal Taxation

Calculation of imputed income and tax liability for non-dependent domestic partner health insurance coverage:

 

Single Employee

Employee with Spouse

Employee with Domestic Partner

Annual Employee Salary

$ 32,000

$ 32,000

$ 32,000

Monthly Employer Contributions

for Benefits

335

907

907

Annualized Employer Contributions

for Benefits

4,020

10,884

10,884

Imputed Income

–

–

6,864

(10,884 – 4,020)

Taxable Income

32,000

32,000

38,864

Employee’s 2006 Tax Liability

3,155

3,155

4,710

 

*Log Cabin Republicans is grateful for the work of the Williams Institute at the UCLA School of Law for the research and report underlying this document.

 

Learn More about Tax Equity for Domestic Partner Health Benefits