Domestic Partner Benefits Taxable to Employee

Cohabitation can be costly.


his is a tale of two relationships. Ezzon Corp. employs Jay and Pat. Jay has been married to Lisa for two years; Pat has lived with Chris for six years. CPAs who think they are familiar with the rules applicable to unmarried couples living together may be surprised to learn one more way in which the playing field is unequal.


When Jay first joined Ezzon, he became eligible to elect family health care coverage for himself and Lisa. The health insurance premiums are deductible from his pay on a pretax basis, saving tax dollars. Further, the cost to Ezzon of the family coverage, above the premiums Jay pays, is not included in Jay’s income and is nontaxable. Under Ezzon company policy, this will be the case even if the couple has children and the cost of family coverage increases.


The situation is not as rosy for Pat and Chris, though. They are domestic partners; basically, they are an unmarried couple over age 18 sharing a common residence. Although Ezzon offers domestic partner health care benefits, Pat must pay the insurance premiums on an after-tax basis.

According to IRS Letter Ruling 200108010, this is because the IRS is barred from treating Chris as Pat’s spouse under Section 3 of the 1996 Defense of Marriage Act, which provides that “‘marriage’ means only a legal union between one man and one woman as husband and wife…” and that “‘spouse’ refers only to a person of the opposite sex who is a husband or wife.”

Under these definitions, a nonspousal domestic partner in either an opposite- or same-sex couple is not a spouse for tax purposes. Earlier, Rev. Rul. 58-66, 1958-1 CB 60 had provided only that the IRS “refuses to recognize a domestic partner as a spouse unless local law recognizes the common-law marriage of the persons involved in the relationship.”

Moreover, the excess of the fair market value of the group medical coverage provided to Chris, the domestic partner, over the premiums Pat pays, is taxable to Pat as ordinary income under Code Section 61; it is considered wages for unemployment, Social Security and income tax withholding purposes.


At Ezzon, family health care coverage is worth $5,000 per year for 2001; a married employee pays $2,000 in premiums. Thus, $2,000 is deducted from Jay’s salary on a pretax basis over the course of 2001, saving him taxes on that income. However, Pat must pay the $2,000 on an after-tax basis; further, Pat’s 2001 Form W-2 reflects $3,000 of income ($5,000 – $2,000), from which federal and state income taxes, unemployment and Social Security taxes must be withheld.

A corollary disadvantage is that Pat will also have to include in income the cost of any group-term life insurance provided to Chris. This differs from the general rule; under Section 79(a)(1), an employee is normally taxed only on the cost in excess of the first $50,000 of coverage.


The only way for Pat to avoid the income inclusions is if Chris can qualify as Pat’s dependent. This is a very difficult standard to meet; there are tests under Code Section 152(a)(1)–(8) that would involve, for example, Pat having to furnish more than one-half of Chris’s support in 2001; moreover, under Section 152(b)(5), their relationship cannot violate local law.

According to IRS Letter Ruling 9850011, Pat and Chris may even have been required to file a declaration of domestic partnership with Ezzon to allow Chris to qualify for health care coverage.


HR 638, the Domestic Partnership Benefits and Obligations Act of 2001, introduced in the House on February 14, would extend to domestic partners of federal employees the benefits available to spouses of these employees.

Employees would have to file an affidavit of eligibility that covers the following:

The employee and domestic partner are each other’s sole domestic partner and intend to remain so indefinitely.

The parties share a common residence and intend to continue the arrangement.

The parties are at least 18 years old and mentally competent to consent to contract.

The couple share responsibility to a significant measure for each other’s common welfare and common financial obligations.

The parties are not married to or domestic partners with anyone else.

They understand that willful falsification of information within the affidavit may lead to disciplinary action and the recovery of the cost of benefits received.

The parties are either:

1. Same-sex domestic partners and not related in a way that, if the two were of the opposite sex, would bar legal marriage in the state in which they reside.

2. Opposite-sex domestic partners and not related in a way that would bar legal marriage in their state.

With more and more couples today opting to live together, it can be a shock to learn that some employer-provided fringe benefits generally thought of as excludible are actually includible in income. CPAs need to be aware of these rules in advising cohabiting clients.

—Lesli S. Laffie, JD, LLM
Technical Editor,
The Tax Adviser


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