May 5, 2005


Surprise: taxes due for domestic partner workplace benefits

A story published today in the Washington Post reports that many employees are surprised to learn that employers must withhold taxes from most employees who receive health and other benefits for their domestic partners.

For example, consider Dan Jessup who in early 2004 added his partner of two years to his health insurance, as his employer, the big Wall Street firm J.P. Morgan, allows.

For more than a decade, a focus of gay rights groups and other activists has been persuading employers to offer health insurance and other benefits to the domestic partners of unmarried employees. And Jessup was pleased that his employer was among those that did.

Employer-provided group insurance "was a great plus for us because he is a self-employed writer and content developer" and J.P. Morgan's coverage "was much cheaper than what he could get on his own," Jessup said of partner Bob Chenoweth.

But there was shock in store for the 39-year-old worker in Morgan's commercial banking division in Indianapolis: His taxes took a big jump.

"Something I didn't understand at the time was how much the taxes would be. I was very surprised when I started doing my taxes" this spring, he said.

As an increasing number of employers make health care coverage available, unmarried workers are finding that as one barrier falls, another remains standing: taxes.

Whether in same-sex or heterosexual unmarried unions, employees who take advantage of health care coverage for their partners are stuck with tax bills for the benefits.

Under federal law, any portion of an employer-paid insurance premium that goes for coverage for a domestic partner is treated as taxable income to the employee. The employee also may not make any payments for partner coverage, such as premiums under a "cafeteria" benefit plan, with pretax dollars.

The rules apply whether an employer buys medical coverage from an insurance company or whether it "self-insures" and allocates part of the costs to the worker, said Randall Abbott of the Boston office of Watson Wyatt Worldwide, a benefits consulting firm.

"Regardless, it's the employer portion of that premium. If the employer is paying 80 percent, that's what the employee is taxed on. The employer withholds taxes on it, and it is reported as income on the employee's W-2" wage reporting form, Abbott said.

Rising medical costs have added to the pain this year, Jessup said. In January of this year, as health care costs to the firm increased, taxes increased proportionately.

"My taxes went up $150 a month. That's something I hadn't planned for," he said of the reduction in his paycheck caused by additional withholding.

Employers often blame the Internal Revenue Service for the tax, but the rules were written into law by Congress.

And because it is federal law, there are other consequences. One is that employers are not required to offer COBRA benefits -- which allow employees to stay on their employers' plans temporarily after they leave their jobs -- for domestic partners.

The taxes are the result of the interaction of several laws.

First, employer-paid health insurance is tax-free only for employees, their spouses and dependents. "A man and a woman who have not officially gotten married are in the same boat," said Christopher Colwell of the accounting firm BDO Seidman LLP.

Opposite-sex couples, of course, have the option of getting married. Except in Massachusetts, same-sex couples do not. Even if they did, it wouldn't help with the tax treatment.

The Defense of Marriage Act, passed by Congress and signed by President Bill Clinton in 1996, defines marriage for the purposes of federal law as "a legal union between one man and one woman as husband and wife."

It also stipulates that "spouse" refers "only to a person of the opposite sex who is a husband or a wife." The law requires that both these definitions be used "in determining the meaning of any Act of Congress."

Thus, same-sex couples, no matter what the states do, will remain unable to get federal-tax-free health insurance for one partner through the other's employer. A 1997 study by the General Accounting Office (now known as the Government Accountability Office) found 1,049 federal laws in which marital status is a factor. They range from the obvious, such as those concerning joint tax returns, to the obscure but potentially important for certain individuals, such as in determining who gets life insurance proceeds when a federal government worker dies without specifying a beneficiary.

For many couples, the most immediate and painful impact is on health insurance.

While most workers can afford to pay the taxes -- or will struggle to do so because the advantage of employer-paid plans is so great -- some cannot.

It is a "decision people have to make," said Joe Solmonese, president of the Human Rights Campaign, a gay and lesbian rights advocacy group here. At the same time, he said, it's a decision society also should face: "What you have to factor in is the cost of the uninsured . . . the long-term cost of the uninsured partner of the person who makes that tough decision" to forgo coverage because of the taxes.

And those who get sick and are without insurance are likely to end up on some form of public assistance, such as Medicaid.

Solmonese said federal policy runs increasingly counter to what many employers are doing. "They see this not just as an issue of workplace equity but, for a whole range of reasons, [as] something that makes a lot of sense," he said.

Forty to 45 percent of the Fortune 500 companies offer domestic partner benefits, Abbott said. Among all large employers, those with more than 1,000 workers, the figure is about 30 percent, he said.

Among all businesses, "the number drops to 15 to 20 percent because many small businesses either simply can't afford the benefit" or their owners may object for personal reasons, he said.

Early on, there was "enormous concern that including same-sex partners would create crippling costs," Abbott said. "That has proven not to be the case. Generally, what we have found is the cost of domestic partner benefits has been nominal," about the same for same-sex and a little higher for opposite-sex unmarried partners as for spouses. Domestic partner benefits can escape tax if the non-employee partner can qualify as the employee partner's dependent. Children of the non-employee partner may also qualify this way.

To qualify, the partners must, among other things, live together, and the employee partner must provide more than half the non-employee's support. Some employers provide worksheets for employees to help figure out if they qualify.

For many couples, "it's difficult to meet that definition of dependent," Colwell said.

Jessup has considered claiming Chenoweth as a dependent but hasn't tried it.

"The tax laws are confusing. We need to talk to specialists," Jessup said. "We don't understand what that would do to his tax situation. He's self-employed -- how is that going to impact his business? It's complex and somewhat overwhelming."

There have been efforts in Congress to ease the tax treatment of health insurance for domestic partners, but they have stalled. Sens. Gordon Smith (R-Ore.) and Charles E. Schumer (D-N.Y.) plan to reintroduce legislation that would bring the treatment more in line with that of married couples.

Jessup and others at J.P. Morgan say they appreciate what the firm has done for them. A company spokesman noted that J.P. Morgan has provided domestic partner benefits since 1994 and was the first Wall Street firm to do so.

But even for investment bankers, the tax hit is not negligible.

Five years ago, when Laureen Callo's partner decided to leave J.P. Morgan and go back to graduate school, Callo added her as a domestic partner.

"It's much more affordable" than other options they looked at, but it resulted in $5,000 a year in additional taxable income. "In the 35 percent tax bracket . . . you are talking about $1,800 a year in tax saving" they would have been allowed if they were married, Callo said. "Over five or six years, that's not small change."