Warning: this is a lengthy article, but packed with valuable information. I hope you can refer to it often.
We are often asked “If a domestic partner can easily be added to the medical plan, why can’t the employee pay for coverage with pre-tax dollars?”
To clarify: we are not talking about a spouse. A “spouse” includes all legally married couples – opposite sex or same sex.
In this article, we are discussing domestic partners. Our definition of “domestic partners” includes unmarried opposite sex or same sex partners (including individuals in marriage-equivalent civil unions or domestic partnerships).
While employers can allow their group benefit plans to cover domestic partners, this article is to address the complexities of the Federal tax treatment of employer-provided health coverage for domestic partners.
Who qualifies as a Qualified Domestic Partner?
To be considered qualified for pre-tax coverage, a domestic partnership must pass four tests:
- Relationship
- Income
- Support, and
- Not Anyone’s Qualifying Child.
Let’s look at each “test”.
Relationship Test: To qualify for pre-tax coverage a domestic partner (DP) must have a specific relationship to the employee. This means, for the taxable year, the DP has the same principal place of residence as the employee and is a member of the employee’s household.
Income Test: The DP’s gross income must be less than the Code §151 exemption amount. There are two types of exemptions, both of which reduce personal income: personal exemptions and exemptions for dependents. For example, for taxable years beginning in 2017, the exemption amount for dependents under Code §151(d) is $4,050.
Support Test: The employee must provide over half of the DP’s support. Support includes food, shelter, clothing, medical/dental/vision care, education, etc. To determine whether an employee has provided more than half of the support for a DP, all sources of support generally are taken into account.
Not Anyone’s Qualifying Child Test: The DP must not be anyone’s qualifying child or the dependent of anyone else for Federal tax purposes.
If they pass?
If the domestic partnership passes all four tests, the DP partner is a Code §105(b) dependent. The employee may then pay for the DP’s insurance premiums with pre-tax dollars. As well, the employee may run the qualifying domestic partner’s expenses through a Health Flexible Spending Account (FSA), Health Reimbursement Arrangement (HRA) or Health Savings Account (HSA).
But, it’s complicated.
Just because you can do something, doesn’t mean you should. The actual application of allowing an employee to pay a domestic partner’s premiums pre-tax gets complicated, for example:
- How should residency and support be verified?
Many employers require the employee to provide a certification or affidavit at the beginning of the plan year which declares that the domestic partner will qualify as a Code §105(b) dependent and requires the employee to notify the employer of any changes.
- What if the DP ceases to be a tax dependent during the upcoming year?
The employee would need to request a midyear election change to impute income for the value of the coverage. The employer would then need to impute income to the employee equal to the value of coverage from the beginning of the year to the change date, in addition to imputing income for the coverage on a prospective basis.
And, there are more burdens associated with initially determining (and monitoring) whether domestic partners qualify as Code §105(b) dependents.
- What if they cease to meet the qualifications midyear by changing residency? Or,
- What if the amount of support the employee provides decreases because the domestic partner’s income increases?
What about the dependent of a dependent DP?
For the dependent of a dependent DP to qualify for pre-tax coverage, they must first qualify as a legal dependent. A legal dependent child is to the employee: a son, daughter, stepson or stepdaughter and includes both a legally adopted individual of the employee and an individual lawfully placed with the employee for legal adoption with the employee. The term “child” also includes an eligible foster child, defined as a child placed with the employee by an authorized placement agency or by judgment, decree or other order of any court of competent jurisdiction.
A domestic partner’s child (under age 27) would qualify as the employee’s legal dependent child if he or she falls into any one of the above categories. Additionally, the employee might be deemed the stepparent of his or her DP’s child under State law which is also true for Federal income tax purposes.
If the DP’s child meets the qualification of an employee’s dependent, then the same four tests must be applied for pre-tax coverage: Relationship, Income, Support, and Not Anyone’s Qualifying Child. A domestic partner’s child may live with the employee, but if the DP does not qualify as a Code §105(b) dependent then it is likely because of income, and thus, the child would not qualify because they depend largely on the DP parent for financial support and not the employee. It is also possible the child is the tax dependent of the child’s other parent.
The test results are clear.
If the domestic partner or the child of a DP, who is not also the child of the employee, do not pass all four tests then he/she is not a legal Code §105(b) dependent and the employee cannot:
- Pay any part of the insurance premiums on a pre-tax basis.
- Submit any expense of the domestic partner/domestic child through a FSA, HRA or HSA.
Special Note: If the employee covers a non-qualifying domestic partner or domestic child on an HDHP HSA medical plan, premiums must be paid with after-tax dollars but the domestic partner may open his or her own Health Savings Account bank account and the employee may deposit after-tax contributions to that account on behalf of the domestic partner.
Why not avoid the whole mess altogether?
Can’t an employer avoid administrative and tax complexities by stating that domestic partner health benefits must be paid by the employee with after-tax dollars or exclude domestic partners from coverage under Health FSAs, HRAs or HSAs?
Historically, cautious employers would offer pre-tax treatment for qualifying Code §105(b) domestic partners because older court cases and the EEOC were protecting employees from discrimination on the basis of sexual orientation. However, with the prevalence of same-sex marriage throughout the country, this risk of “discrimination on the basis of sexual orientation” is greatly diminished and should allow employers to impose a rule to deduct premiums of a domestic partner with after-tax dollars and avoid the administrative hassle altogether.
What should an employer do?
It is our recommendation to avoid burdens associated with determining and monitoring whether domestic partners and domestic children qualify as Code §105(b) dependents (as well as prevent the possibility of a “water cooler” discussion where one employee says he gets his DP’s premiums pre-tax and another employee says she was told she couldn’t) by implementing a policy that insurance premiums and expenses of such individuals are not to be paid by the employee with pre-tax dollars. Since so few individuals will qualify as Code §105(b) dependents it seems a very few individuals will be adversely affected. Employers will definitely save themselves some headaches by not permitting it for all.