Working Families Tax Relief Act Affects Domestic Partner Benefits (Posted on October 29, 2004 by )

After publication of this article, the Supreme Court issued United States v. Windsor. That decision overturned the Defense of Marriage Act, which had previously prevented federal recognition of same-sex marriage. Thus, this article is now obsolete as to same-sex spouses, although it continues to apply to domestic partners who are not legally married.

One issue that has been completely ignored in the press surrounding the Working Families Tax Relief Act of 2004, Public Law No. 108-311 (“Act”), is the apparently unintentional effect it will have on employers that sponsor employee benefit plans covering domestic partners or same-sex spouses of employees, and on employees whose domestic partners or same-sex spouses are covered by such plans. Because the relevant provisions of the Act will become effective starting in 2005, employers that sponsor such plans will have to act quickly to deal with the changes made by the Act.

Importance of definition of “dependent” for domestic partner benefits

As background, Private Letter Ruling 200108010 (February 23, 2001) provides guidance on the tax consequences of a health plan that provides coverage for the domestic partners of employees. In summary, it holds that:

  1. If coverage is provided to a domestic partner who is the employee’s dependent within the meaning of section 152 of the Internal Revenue Code (“Code”), the value of the coverage excluded from the employee’s gross income under Code section 106 and is not wages for employment tax purposes, but
  2. If coverage is provided to a domestic partner who is not the employee’s dependent, the excess of (a) the fair market value of the coverage provided to the domestic partner over (b) the amount paid by the employee for such coverage is includible in the income of the employee for income tax purposes under Code section 61 and is wages for FICA, FUTA and income tax withholding purposes.

Moreover, if the employer elects to “gross up” employees for the tax generated by the domestic partner coverage, the gross-up is itself includible in the income of the employee for income tax purposes under Code section 61 and is wages for FICA, FUTA and income tax withholding purposes.

Same-sex spouses

Private Letter Ruling 200108010 applies not only to unmarried domestic partners of employees, but to a person who is legally married to the employee (e.g., under Massachusetts law) but is of the same sex as the employee. As noted in the ruling, section 3 of the Defense of Marriage Act (P.L. 104-199) provides as follows:

In determining the meaning of any Act of Congress, or of any ruling, regulation or interpretation of the various administrative bureaus or agencies of the United States, the word “marriage” means only a legal union between one man and one woman as husband and wife, and the word “spouse” refers only to a person of the opposite sex who is a husband or wife.

Current definition of dependent

At the time Private Letter Ruling 200108010 was issued, Code section 152 imposed four tests for dependency in the case of adult domestic partners:

  1. The employee had to provide more than one-half the domestic partner’s support.
  2. The domestic partner had to have as his or her principal place of abode the home of the employee and be a member of the employee’s household.
  3. The relationship could not violate local law. (This test has had less meaning in the context of domestic partners since the Supreme Court, in Lawrence v. Texas, struck down state criminal laws regarding private consensual sodomy.)
  4. The domestic partner had to be a citizen or national of the United States, or a resident of the United States or of a country contiguous to the United States. (Although this last requirement might seem to be taken care of by the second one, it excludes certain foreigners such as those on student visas, who may in fact live in the United States for years but are not treated as residing here.)

Obviously, an employer might not be in a position to know whether a domestic partner fulfilled all of these tests. However, the ruling simplified employer fact-finding by permitting an employer to rely on the employee’s certification of the relevant facts.

Effect of the Act

The Act amends Code section 152 to add a fourth element to the definition of dependent: The domestic partner’s gross income for the calendar year in which such taxable year begins must be less than the exemption amount (as defined in Code section 151(d)). That amount is $3,100 for 2004, and is subject to annual cost-of-living adjustments. Thus, as a practical matter, domestic partners and same-sex spouses are now unlikely to qualify as dependents if they are employed on anything other than an extremely part-time basis.

Interestingly, section 207 of the Act specifies that the income limitation on the definition of “dependent” will not apply for certain purposes, including the exclusion of medical benefits paid uner employer-provided health insurance from income pursuant to Code section 105. However, section 207 of the Act does not list Code section 106 (which governs the taxation of health insurance premiums, as opposed to medical benefits paid by insurance) among the sections that are to be applied without regard to the maximum income limitation in section 152. Although some have suggested that this was a technical oversight, it would presumably require further legislation to correct it if that is the case.

What does the Act require of employers?

For employers, the Act presents two issues. First, if they have been relying on certifications from employees regarding the dependency status of domestic partners or same-sex spouses, they will have to amend their certification forms to require certification that the domestic partner’s income is below the exemption amount almost immediately, since the Act becomes effective for wages paid in 2005. Second, to the extent that employers have been providing a gross-up of the taxes generated by providing domestic partner or same-sex spouse coverage, the cost of such gross-up is likely to increase dramatically as fewer domestic partners or same-sex spouses qualify as dependents.