Eliminating the Tax Penalty on Health Insurance for Domestic Partners
While our country continues to evolve in its views towards gay and lesbian couples, our tax code lags. For example, businesses now routinely offer family health care benefits to domestic partners and same-sex couples who are allowed to marry under state laws, but federal tax law punishes both the businesses that offer these benefits and the employees who use them. It treats the value of these benefits as income, forcing the employer and the employee to pay extra taxes that would not apply to other couples. Not only does this cost more for everyone, it is convoluted to administer, since businesses must keep a separate set of books for employees with a same-sex partner in order to calculate these added taxes—including payroll taxes. Simply changing the tax code to put health coverage for domestic partners on the same footing as coverage of other family members would remove this headache for employers and ensure that all employees are treated equally and can receive the protections they deserve.
The Problem
Health care coverage for a domestic partner is currently taxed as income.
Businesses are increasingly offering family benefits to domestic partners.
An employer’s decision to offer domestic partnership benefits can be driven by a variety of factors, including a company’s desire to remain competitive, a general commitment to fairness for all their employees, or being located in a state that extends marriage to gay and lesbian couples for purposes of state law. As acceptance of gay and lesbian people in our country has risen, a greater number of employers have chosen to offer such protections, and the number of same-sex couples who are eligible for these benefits has increased substantially over the last decade.
For example, according to the Williams Institute, 50,000 same-sex couples have married in the states in which they are allowed to do so, and at least another 85,000 couples have registered for domestic partnerships or civil unions under various state laws that purport to grant the same rights and responsibilities as marriage.1 And many companies have gone further and extended domestic partner protections to couples in states that do not yet have statewide relationship recognition laws. In fact, well over half of the Fortune 500 companies now offer domestic partnership protections,2 and the overall number of large employers to do so continues to rise, increasing from 12% in 2000 to 34% in 2008.3 And often, these businesses voluntarily provide health care coverage for opposite-sex domestic partners as well as same-sex domestic partners. In fact, employers provide domestic partner protections more often to straight couples than gay couples.4
There’s a legal loophole that singles out those protections for extra tax.
The tax code hasn’t caught up with employment practices and legal changes to the family. Generally, the cost of employer-provided health coverage is excluded from an employee’s income under the tax code. However, the provision that governs this exclusion applies only to health care coverage for the employee, his or her opposite-sex spouse, and the employee’s dependents—not to a domestic partner. Even in states where gay couples may marry, the Defense of Marriage Act keeps them from being counted as “spouses” under any federal tax law. Therefore, unlike with opposite-sex spouses, the value of health care coverage offered to domestic partners or same-sex spouses is counted as income to the employee, even though the worker never sees an extra dime in his or her paycheck. The law essentially singles out domestic partner coverage to count it as “imputed income” to an employee, treating health care for same-sex domestic partners, same-sex spouses, and opposite-sex domestic partners differently than employer-provided health care for other family members.
The exception creates an administrative mess and extra cost for businesses.
Because health care for domestic partners is singled out to be counted as income, an employer who offers such benefits must keep a separate set of books for any employee who avails themselves of this option, as well as paying additional payroll taxes on this imputed income. To make matters worse, the IRS has refused to issue guidance on how to calculate the fair market value of this health care coverage, leaving employers to estimate imputed income without the benefit of clearly established rules.
Below is an example of payroll taxes paid by a business for an employee who receives health care coverage for an opposite-sex spouse, compared to a worker who instead covers a domestic partner.5
A 2007 study by the Williams Institute estimated that employers pay approximately $57 million dollars in extra payroll taxes per year due to this provision.6 In addition to these extra FICA taxes, some companies have begun a practice of “grossing up” or paying employees who cover domestic partners an additional amount each year to offset the extra tax burden the employee will accrue due to this disparate treatment.7 This practice, while admirable in its goal of fairness to all employees, can potentially add thousands of dollars per employee to the costs for businesses that choose it. However, some companies have found that without grossing up, few employees will take advantage of the domestic partnership protections they seek to offer, since the value of those benefits is substantially diluted by the federal government’s singling them out for additional tax.
It unfairly adds to the tax burden of employees with domestic partners.
Employees who receive employer-provided health care coverage for their domestic partners are penalized by federal tax law, forced to pay on average over $1,000 more in taxes a year than an employee who covers a spouse.8 Below is an example of tax liability for a worker who covers an opposite-sex spouse, compared to an employee who covers a domestic partner.9
In addition to this added income tax burden, an employee is also barred from using tax-preferred accounts like Flexible Savings Accounts (FSAs) for the cost of health care for a domestic partner. Under the Affordable Care Act, up to $2,500 can be placed in a tax-free FSA to be used for employee contributions towards health insurance, as well as other health care expenses. For the employee above, this inability to utilize an FSA for domestic partner health insurance and expenses could add another $625 to his or her income tax, raising the employee’s total extra tax liability to $1,717.
The Solution
Treat all beneficiaries equally for tax purposes.
Congress could remove this administrative headache for businesses and ensure that all employees are on a level playing field by passing the Tax Equity for Health Plan Beneficiaries Act. The bill would simply change the tax code to put health coverage for domestic partners and same-sex spouses on the same footing as coverage of other family members. In the 111th Congress, this legislation garnered bipartisan support in the House with 133 cosponsors led by Rep. Jim McDermott (D-WA) and Rep. Ileana Ros-Lehtinen (R-FL). In the Senate, the bill was bipartisan as well, and it was spearheaded by Sen. Chuck Schumer (D-NY) and Sen. Susan Collins (R-ME), along with 21 of their Senate colleagues. Language mirroring the Tax Equity for Health Plan Beneficiaries Act was also included in the initial House-passed version of health care reform in 2009, but the final version of the Affordable Care Act did not include this loophole-closing language. However, legislators in both chambers plan to reintroduce these bills in the 112th Congress.
Critiques & Responses
It’s too expensive.
Treating domestic partners like other family members when calculating taxes on health insurance would not have a significant financial impact on the federal government. Currently, it is estimated that employers and employees are paying approximately $235 million in additional taxes due to the disparate taxation of health insurance for domestic partners.10 The only cost of equalizing their treatment would be the loss of this extra tax revenue. But when compared to the $160 billion cost per year of the general policy excluding all employer-provided health coverage from taxable income, the cost of fixing this problem for domestic partner coverage would be approximately 0.1% of that total figure.11
Employers shouldn’t be forced to cover gay couples.
The bill would not force any business to offer benefits or protections to anyone—it would simply allow companies to make their own decisions about who should receive employer-provided health care coverage and equalize treatment of coverage for the beneficiaries designated by the employer and employee.
It will lead to fraud or a slippery slope.
Businesses are already paying for these benefits, so it is in their financial interest to limit them to legitimate family members. Closing the loophole that currently treats domestic partners differently than other covered family members would not change the rules that companies apply to determine who is a domestic partner, nor would it open the floodgates to a new set of beneficiaries. It would merely place businesses who voluntarily provide domestic partner protections on the same footing as other employers and ensure that all workers receive their employer-provided coverage on equal footing.
Appendix
Endnotes
“Williams Institute Experts Comment on Department of Justice DOMA Decision,” Press Release, The Williams Institute, February 24, 2011. Accessed May 9, 2011. Available at: http://www3.law.ucla.edu/williamsinstitute/pdf/Pressrelease2.24.pdf.
“The State of the Workplace for Lesbian, Gay, Bisexual and Transgender Americans 2007-2008,” Report, Human Rights Campaign Foundation, February 20, 2009, p. 9. Accessed May 9, 2011. Available at: http://www.hrc.org/documents/HRC_Foundation_State_of_the_Workplace_2007-2008.pdf.
“Health Insurance Options for Domestic Partners,” Consumer Alert, National Association of Insurance Commissioners, July 2009, Accessed May 9, 2011. Available at: http://www.naic.org/documents/consumer_alert_domestic_partners.htm.
“Employer Health Benefits 2009 Annual Survey,” Kaiser Family Foundation, September 2009, pp. 42-43. Accessed May 9, 2011. Available at: http://ehbs.kff.org/pdf/2009/7936.pdf.
The Medical Expenditure Panel Survey identifies the average cost of employer-provided health insurance for an employee plus one additional adult as $9,053. The average employee contribution to such plans is $2,363, leaving $6,690 to be paid by the employer. In order to calculate the additional tax burden, this employer contribution must be divided in half to isolate the cost of coverage for only the domestic partner: $3,345. See United States, Department of Health and Human Services, Agency for Healthcare Research and Quality, “Medical Expenditure Panel Survey,” 2009. Accessed May 9, 2011. Available at: http://www.meps.ahrq.gov/mepsweb/index.jsp.
M.V. Lee Badgett, “Unequal Taxes on Equal Benefits: The Taxation of Domestic Partner Benefits,” Report, The Williams Institute and Center for American Progress, December 2007, p. 7. Accessed May 9, 2011. Available at: http://www3.law.ucla.edu/williamsinstitute/publications/UnequalTaxesOnEqualBenefits.pdf.
Tara Siegel Bernard, “The Tax Treatment of Domestic Partner Benefits,” Blog, The New York Times, June 30, 2010. Accessed May 9, 2011. Available at: http://bucks.blogs.nytimes.com/2010/06/30/the-tax-treatment-of-domestic-partner-benefits/.
M.V. Lee Badgett, “Unequal Taxes on Equal Benefits: The Taxation of Domestic Partner Benefits,” Report, The Williams Institute and Center for American Progress, December 2007, p. 7. Accessed May 9, 2011. Available at: http://www3.law.ucla.edu/williamsinstitute/publications/UnequalTaxesOnEqualBenefits.pdf.
The Medical Expenditure Panel Survey identifies the average cost of employer-provided health insurance for an employee plus one additional adult as $9,053. The average employee contribution to such plans is $2,363, leaving $6,690 to be paid by the employer. In order to calculate the additional tax burden, this employer contribution must be divided in half to isolate the cost of coverage for only the domestic partner: $3,345. See United States, Department of Health and Human Services, Agency for Healthcare Research and Quality, “Medical Expenditure Panel Survey,” 2009. Accessed May 9, 2011. Available at: http://www.meps.ahrq.gov/mepsweb/index.jsp.
M.V. Lee Badgett, “Unequal Taxes on Equal Benefits: The Taxation of Domestic Partner Benefits,” Report, The Williams Institute and Center for American Progress, December 2007, p. 7. Accessed May 9, 2011. Available at: http://www3.law.ucla.edu/williamsinstitute/publications/UnequalTaxesOnEqualBenefits.pdf.
M.V. Lee Badgett, “Unequal Taxes on Equal Benefits: The Taxation of Domestic Partner Benefits,” Report, The Williams Institute and Center for American Progress, December 2007, p. 8. Accessed May 9, 2011. Available at: http://www3.law.ucla.edu/williamsinstitute/publications/UnequalTaxesOnEqualBenefits.pdf.
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