Tax code may offer relief for some domestic partners
by Matthew S. Bajko
The health care reform bill passed into law last month failed to include a provision that would have eliminated the taxation of domestic partner benefits. As it stands now, many domestic partners face an unfair tax burden because the federal government taxes the health benefits their employer provides to their partner.
The issue is sure to impact more domestic partners in 2014 when, under the new federal legislation, all Americans will be required to have health insurance. Many same-sex couples will likely sign up their partner under their employer-provided coverage in order to meet the requirement.
But it is doubtful that Congress will address the taxation of domestic partner benefits by then. And unless an LGBT employee's pay is "grossed up," in which their employer pays them more to offset the tax burden on their partner's health insurance, they will be hit with a larger tax bill than their heterosexual married co-workers who do not face the same federal tax penalty.
But there is a little known provision in the tax code some domestic partners can use to avoid the health benefits tax. Under certain conditions, a person can claim their domestic partner – or spouse in those states where same-sex marriage is legal – as their "tax dependent."
Under Internal Revenue Code Section 152, a dependent usually means a qualifying child or relative. Yet as defined by the IRS, a relative could be an LGBT person's partner because of the fact that the federal government does not recognize domestic partnerships or same-sex marriages.
As explained in paragraph 2(h) under Section 152, a relative can be "an individual who, for the taxable year of the taxpayer, has the same principal place of abode as the taxpayer and is a member of the taxpayer's household." The IRS excludes a person's spouse under this definition, but for same-sex couples whose relationships are not recognized federally, the exemption then applies.
There are also income restrictions that must be met, such as the taxpayer has to provide for more than one-half of the tax dependent's support during the calendar year and the person's gross income during the taxable year has to be less than the exemption amount.
"If you look at Section 152, there is more than one way to skin the cat here in order to be a dependent under the tax code," said Todd A. Solomon, a partner in the Chicago law firm of McDermott Will and Emery who is a straight member of the firm's Lesbian, Gay, Bisexual and Transgender Diversity Committee. "For two partners, if one works and the other one doesn't work, they would be a tax code dependent."
Solomon said it could also apply in the case of a same-sex couple where the two partners have great income disparity, such as one person earns $150,000 or more a year and the second person makes $50,000 or less.
"You can have a person who makes $60,000 but they still have someone who provides half their support if you have one really expensive lifestyle," said Solomon. "There is no cap really to the 50 percent of support. It is not really well-defined in the tax code what that support is other than it is living expenses."
Many LGBT people and their employers, however, are not aware of this loophole in the tax codes. Even some tax professionals are not aware of the exclusion DPs can use, said Solomon.
"There is a lot of misunderstanding around it. Tax accountants don't understand it," he said. "You can have a situation where somebody is dependent for health care purposes but not for general tax purposes. It kind of gets confusing."
A review of the guide San Francisco provides to its city employees explaining their health benefits, which is available online, shows that the Health Services System does warn domestic partners about the federal tax consequences and notes that the state of California does not tax the benefits.
But it does not explain to DPs how to avoid the federal taxes by using the dependent exemption under the tax code.
Jennifer Johnston, the department's spokeswoman, directed questions about the guide to Catherine Dodd, director of the health services system. Dodd, who was named to the post last year, did not return a call seeking comment by press time.
Speaking at a marriage symposium held by the University of San Francisco in late February, Santa Clara Law Professor Patricia Cain said the IRS has done a poor job of publicizing the DP tax break to employers.
"Lots of domestic partners and their children out there qualify as dependents and should be getting a tax break," said Cain. "You may think a domestic partner can't be a dependent, but they can if you know where to look in the tax laws."
For her talk Cain Googled the domestic partner benefit plans for 35 major universities in the country to see if they explained how their LGBT employees could avoid being taxed on their partner's benefits. Only two of the schools, she said, earned an A grade for having simple instructions explaining the tax rules. Nine of the colleges failed.
"Only 22 percent of the schools can you conclude if your domestic partner is your dependent. Seventy-eight percent of the schools give you the wrong information or send you to the wrong tax code," said Cain. "I find this outrageous."
The University of Iowa stands out, said Cain, as an exemplary institution when it comes to explaining how DPs can be classified as tax dependents. In fact, one can easily find online the university's worksheet it uses to guide its LGBT employees through the process of determining if they and their spouse qualify as dependents under the tax code.
"Our forms that we developed are still being used by a lot of employers around the country," said Richard Saunders, the University of Iowa assistant vice president of human resources who oversees the DP program. "We spent a lot of time researching all the tax ramifications these individuals have to face. We don't give tax advice but we did put out the information on our Web site."
The university, where Cain previously worked, was one of the first to begin offering DP benefits when it began doing so in 1992. Saunders said 226 registered domestic partners, 74 of whom have now married in the state, receive benefits from the school. But he said it is unknown how many of those claim their partner as a dependent for tax purposes.
Tax experts advise that the best thing for DPs to do is to consult with a tax expert who has experience working with LGBT couples.
"We always caution everyone if they are unsure they should really talk to whoever can work with their taxes with them just to be on the safe side," said Saunders. "We don't hold ourselves out to be tax experts at all."