California Provisions
In September 2004, the California Insurance Equality Act was signed into law by Governor Arnold Schwarzenegger. Effective January 1, 2005, this law will require group health plans, health insurance and all forms of insurance, to provide coverage to registered domestic partners equal to coverage provided to spouses. Domestic partner coverage (as defined by the state's domestic partner registration requirements in the California Family Code) will become a requirement for insurance contracts issued, amended, delivered or renewed on or after January 1, 2005. The provisions of AB 2208 applicable to health plans make it a requirement for contracts issued, amended, delivered or renewed on or after January 2, 2005.
Under California law, a domestic partnership is permitted between two adults of the same sex, or between two persons of the opposite sex if one or both are over age 62 (and the over 62 partner meets eligibility requirements for Social Security or Supplemental Security benefits). Domestic partners must be at least 18, must share a common residence, not be married or a member of another domestic partnership, and must not be related by blood in a way that would otherwise prevent them from being married in the state of California. Under the provisions of AB 205, California law extends the rights and duties of marriage to persons registered as domestic partners on and after January 1, 2005. California law will also now require that the superior courts have jurisdiction over all proceedings governing the dissolution of domestic partnerships, annulment of domestic partnerships, and legal separation of partners in domestic partnerships. These proceedings will follow the same procedures as the equivalent proceedings with respect to marriage. Further details about changes in state procedures for registering or terminating a domestic partnership are located at the Secretary of State's website at: http://www.ss.ca.gov/dpregistry/.
AB 2208 clarifies that under the new law, "terms," "conditions," and "coverage" do not include instances of differential treatment of domestic partners and spouses under federal law. Therefore, certain benefits (such as COBRA continuation coverage and Section 125 provisions) could not be provided to domestic partners, since federal law does not consider domestic partners in the same way as a spouse of an employee. One issue that is not clear is whether the ERISA preemption provision will apply to this California law, although nothing would restrict a self-funded plan from adopting this domestic partner eligibility requirement. If ERISA does preempt AB 2208, self-funded plans would be exempted from the requirement. This issue will likely be tested in court, and employers are advised to consult their legal counsel for guidance on the application of AB 2208 to their self-funded plans if they intend to assert the ERISA preemption.
We recommend that employers utilize the state's registration process and eligibility criteria for verification of domestic partnerships. Rather than an employer having their own registration or affidavit for establishing a domestic partnership, employers will be able to accept the state registration as acceptable proof of a valid domestic partnership. However, employers who expand the availability of benefits for opposite-sex domestic partnerships need to continue using their own eligibility and verification procedures for domestic partnerships outside the state registration criteria.
Since 2002, California tax law has extended tax benefits to domestic partner health coverage, and excludes amounts for the coverage from gross income. Note that this is only applicable state tax law, and does not change the taxability of domestic partner benefits under federal tax law. Employers will still need to report the value of domestic partner coverage on employees' W-2s, and employees with domestic partners should be advised to consult a qualified tax professional as to the applicability of federal and state tax laws to their personal situation.
With the passage of these laws, it is possible that California-registered domestic partnerships may meet the requirements of IRC Section 152, if IRS Private Letter Rulings (PLR) and field service advice memoranda (FSAM) fit the circumstances (please see the discussion of these items under Federal Provisions Relating to Domestic Partner Benefits, below). The FSAM indicates that local law determines whether a relationship between an employee and another individual is legally recognized, and if so, that the individual can hold the status of a Section 152 dependent. FSAMs are nonbinding advice from the IRS Office of Chief Counsel; they do not have the force of regulations or a court decision. Keenan & Associates is not advising our clients that California law will allow domestic partner coverage on a tax-preferred basis, but indicating that circumstances exist that may allow it. Employees covering their domestic partners should consult competent legal and/or tax counsel to examine the applicable IRS guidance in relation to their own tax situation to determine the taxability of their benefits.
Finally, a California law passed in 2002 (SB 1661), permits an employee to utilize Paid Family Leave (PFL) benefits of up to six weeks of wage replacement for an employee to take time off work to care for seriously ill family member, including a domestic partner. PFL benefits also apply to the birth of a child of the employee or the employee's domestic partner, or the placement of a child with the employee in connection with the adoption or foster care of the child by the employee or the employee's domestic partner. This new state benefit was effective July 1, 2004 for all employees currently covered under State Disability Insurance (SDI).
Federal Provisions Relating to Domestic Partner Benefits
The implementation of domestic partner benefits involves important considerations with respect to tax implications and benefits administration. Since 1999, California has enacted significant legislation that has facilitated the growth of domestic partner benefits in the state. At the same time, federal law does not generally recognize domestic partnerships as having the same standing as a qualified dependent, unless certain specific criteria are met. Unless a domestic partner can be qualified as a dependent, the fair market value of health coverage provided to the domestic partner is taxable income to the employee. This income must be reported on the employee's W-2, and is subject to withholding for income, FICA, and FUTA taxes. In addition, the same federal dependent definitions also exclude domestic partners from coverage under Section 125 plans, and do not extend continuation coverage rights under COBRA nor FMLA leave on behalf of domestic partners.
The federal interpretation of how a domestic partner may qualify as a "dependent" as defined under Internal Revenue Code 152 has not been formalized under federal law, or by regulation. However, the Internal Revenue Service has stated some fairly consistent guidelines in several Private Letter Rulings (PLRs) and Field Service Advice Memoranda since 1995. While these guidelines do not constitute advice that a taxpayer can rely on beyond the specific circumstance a PLR addresses, they do give a good indication how the IRS might apply the rules to other similar situations. The IRS indicates that a domestic partner could be treated as a dependent if:
- The domestic partner receives more than half of their support and maintenance for a tax year from the employee;
- The domestic partner uses the home of the employee as their principal residence and is a member of the employee's household; and
- The relationship between the employee and the domestic partner does not violate local law.
Employers may not want to become involved in determining whether or not any given employee's domestic partner meets the definition of a dependent for federal tax purposes. An employer may simply report the value of the domestic partner health coverage on the W-2 and leave it to the employee and their individual tax advisor as to whether the income may be excluded. If the employer does choose to allow employees to provide proof of their domestic partner's dependency criteria, we suggest that this be provided in the form of a notarized affidavit or a current federal tax return that declares the domestic partner as a dependent. Copies of the proof should be maintained by the employer to defend against possible tax penalties for under-reporting of income or failure to withhold. Employers should discuss this issue with their legal counsel to determine their exposure. Also, the capabilities of the payroll and other administrative systems will need to accommodate the potential complexity of multiple categories of benefit taxability.
Under IRC Section 162, employers can deduct their expenses for providing domestic partner health coverage in the same way as health benefits are deductible for employees and dependents.
Further Guidance to Follow
We expect the changes and unresolved questions from the enactment of AB 2208 will require additional guidance as developments emerge. It is likely that some legal issues will require resolution in the courts. We are in the process of completing a more detailed analysis of the California Insurance Equality Act that will include a discussion of its specific provisions and an evaluation of the potential financial impact to employer benefit plans. This analysis should be completed within the next two weeks and we will release it to you as soon as it is available.
Compliance Advisory
Domestic Partnerships: Benefit Issues, September 2004
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Health benefits taxability
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Unless Domestic Partner otherwise meets IRC Sec. 152(a)(9) definition of dependent, value of coverage, minus any employee contribution, is taxable income to the employee under federal law.
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Since 2002, excludes Domestic Partner health coverage from state taxable income if the domestic partnership is registered according to the Calif. Family Code.
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Employer expense deductibility
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Domestic Partner health coverage considered an ordinary business expense under IRC Sec. 162.
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Same as federal.
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Withholding obligation
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Employer must withhold federal income, FICA and FUTA taxes on imputed income (IRC Secs. 3402, 3111, and 3301).
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Same as federal, unless exempted from state taxation under a registered domestic partnership.
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Fair market value of coverage
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No specific regulatory guidance on method; but using either Single rate, or the difference between Single and Two Party rate should be reasonable.
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Same as federal, unless exempted from state taxation under a registered domestic partnership.
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Continuation coverage
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Unless Domestic Partner otherwise meets IRC Sec. 152(a)(9) definition of dependent, COBRA rights do not extend to Domestic Partner. However, nothing prevents an employer from offering such a continuation.
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Generally same as federal law. CalPERS plans extend continuation to domestic partners and dependents upon death of the employee or retiree, but surviving domestic partner cannot add additional family members.
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Section 125
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If not an IRC Sec. 152 dependent, domestic partner contributions cannot be converted to pretax. Health expenses cannot be reimbursed through FSA.
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Same as federal law.
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Domestic Partner eligibility
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No criteria established. For Domestic Partner to qualify under IRC Sec. 152:
(1) must receive more than half of support from the employee, (2) the employee’s home must be the Domestic Partner’s principal residence, and (3) the relationship does not violate local law (Individuals should seek qualified legal or tax advice for their personal situations).
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Effective 1/1/05, domestic partners are eligible for coverage if spouses are eligible for coverage. A domestic partnership is permitted between two adults of the same sex, or between two persons of the opposite sex if one or both are over age 62 (and the over 62 partner meets eligibility requirements for Social Security or Supplemental Security benefits). Domestic partners must be at least 18, must share a common residence, not be married or a member of another domestic partnership, and must not be related by blood in a way that would otherwise prevent them from being married in the state of California
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Domestic Partner coverage requirements
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None.
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Effective 1/1/05, Domestic Partner coverage becomes a requirement if spouses have coverage. HMOs and insured health plans required to cover Domestic Partner on the same terms and conditions as to an eligible spouse of an employee.
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Leave requirements
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FMLA rights do not extend to serious health conditions of a Domestic Partner. Nothing prevents employers from extending more generous family leave provisions than FMLA minimum requirements.
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Employees may use sick leave to care for a Domestic Partner. The Paid Family Leave (PFL) benefit, effective July 1, 2004, will also allow up to 6 weeks of wage replacement for employee to care for a Domestic Partner or bond with a new child.
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