Health insurance premiums for domestic partners

[SLuskin]

We have always advised our clients who offer domestic partner benefits that the premiums for the domestic partner (1) are imputed income to the employee if the premiums are paid by the employer and (2) premiums the employee is required to pay for the domestic partner coverage must be taken from the employee's paycheck on an after tax basis. Today, someone told me that their attorney said the IRS doesn't like the after tax basis for the employee contribution, that it must be taken as pretax and then imputed income back to the employee. EBIA does not agree. Has anyone else heard anything like this?

Thanks so much.

[lvena]

I am only 99% sure about this, but you may be doing this wrong. The Fed Govt tax laws do require the employer contribution to included as income to the employee, as you have advised. But pretax cannot be used. This does not apply in situations where the DP is in a common law situation, or is defined as a IRS dependent.

Hope this helps, and hope I understood your question.

[SLuskin]

I am only 99% sure about this, but you may be doing this wrong. The Fed Govt tax laws do require the employer contribution to included as income to the employee, as you have advised. But pretax cannot be used. This does not apply in situations where the DP is in a common law situation, or is defined as a IRS dependent.

Hope this helps, and hope I understood your question.

Thanks, Ivena, I agree with you. I think pretax cannot be used. The attorney advising my client says pretax is used and then that income is imputed as well. He is from a fairly big firm and has a powerpoint explaining that DP premiums are to be pretaxed and then how to impute the premium.

I have never heard of that before.

[lvena]

I am only 99% sure about this, but you may be doing this wrong. The Fed Govt tax laws do require the employer contribution to included as income to the employee, as you have advised. But pretax cannot be used. This does not apply in situations where the DP is in a common law situation, or is defined as a IRS dependent.

Hope this helps, and hope I understood your question.

Thanks, Ivena, I agree with you. I think pretax cannot be used. The attorney advising my client says pretax is used and then that income is imputed as well. He is from a fairly big firm and has a powerpoint explaining that DP premiums are to be pretaxed and then how to impute the premium.

I have never heard of that before.

Opps... I meant "he" may be doing this wrong, not you. Glad you understood what I was trying to say.

Lee

[GMK]

For what it's worth, we've been told (by a benefits attorney) that we have a choice. We can pre-tax the premium payments and impute the value of the taxable coverage as income to the employee, or we can split the deduction and take the taxable part out after-tax, whichever works best for the payroll department. Either way, the employee pays taxes on the value of whatever coverage isn't exempt from taxes.

For us, pre-taxing the whole premium and imputing the taxable value back to the employee is the simpler approach.

[lvena]

For what it's worth, we've been told (by a benefits attorney) that we have a choice. We can pre-tax the premium payments and impute the value of the taxable coverage as income to the employee, or we can split the deduction and take the taxable part out after-tax, whichever works best for the payroll department. Either way, the employee pays taxes on the value of whatever coverage isn't exempt from taxes.

For us, pre-taxing the whole premium and imputing the taxable value back to the employee is the simpler approach.

Does this decrease the employer tax? It seems to me that the employer has a tax issue now that their payroll cost has been decreased.

[GMK]

For example, employee has $800 of taxable income after pre-tax deductions.

Employee adds coverage for a non-tax dependent (who is not an adult child under age 26), and the value of that coverage is $100.

If I take the $100 out after-tax, then no change. The employee still has a taxable income of $800.

If I take the $100 pre-tax, the employee's taxable income drops to $700. But then I impute the value of the coverage ($100) to the employee, so the employee's taxable income is $800. Same as before, for the employee and the employer.

[QDROphile]

I don't think the mechanics using imputed income are consistent with the cafeterial plan rules even if you get to the same tax result.

[GMK]

I don't think the mechanics using imputed income are consistent with the cafeterial plan rules even if you get to the same tax result.

OK, I'm very interested, but I can't find what you're driving at. Would you please provide some specifics. Thanks.

[QDROphile]

A cafeteria plan provides a choice between cash (taxable compensation) and a non-taxable benefit (employer-provided health benefits for employees and tax dependents). The tax mechanism for implementing the choice is to reduce compensation (so-called "pre-tax" payments) in favor of receipt of nontaxable benefits. Health benefits for a non-dependent domestic partner are not non-taxable benefits. ERISA looks at the arrangement differently, but that is not relevant to a tax discussion.

One can argue that "cafeteria" plans can provide for after-tax payments for benefits. While that appears to be true, the arrangement is not really a cafetria plan under section 125. It can run in conjunction with a cafeteria plan and can be included in the same document as the "true" cafeteria plan. So one can deliver domestic partner benefits through an arrangment that includes a section 125 cafeteria plan, but is is not really correct to use the section 125 mechanism of salary reduction to do so. Section 125 simply solves the constructive receipt problem of allowing a choice between cash remuneration (taxable) and tax-free remuneration. With respect to a choice between cash remuneration and taxable remuneration, section 125 is not needed because everything is taxable. Section 125 simply is irelevant and does not apply.

I have no opinion about what the IRS reaction would be if it confronted a technically improper use when the tax outcome is correct because of the artifice of imputing income. I think the IRS would just ask for better formal compliance prospectively, or not be concerned.

I assume that when you impute income, you are also imputing wages for FICA purposes and other employment tax purposes.

[GMK]

Thanks for responding, QDROphile. I see your point.

Interestingly, places that post their information and forms on-line (mostly universities) state that they will continue the pre-tax premium payments and add the imputed income (the value of non-tax dependent's coverage) to the employee's taxable income. At least the one's I've looked at say that.

Fortunately, imputing income not been an issue for us yet, but we expect to see it eventually here in a state that makes adult children eligible for health coverage to age 27 (and which has not yet 'federalized' adult child dependent status, but that's another story).

I assume that when you impute income, you are also imputing wages for FICA purposes and other employment tax purposes.

yes, that's the plan, subject to further advice from the attorney, etc.

Thanks again.

[LRDG]

IRS is the only reliable source of information regarding benefits, Sec. 125 in particular. There are many to choose from and it can be a temptation, but I don't suggest relying on the online info of any organization. IRS is the only reliable source, other than for purposes of discussion or debate. I'm also leary of a few of the benefit advisor subscription services, as they have not always been 100% reliable or consistent with IRS.

SLuskin, I'd also avoid advice from anyone's attorney who would suggest that the IRS doesn't like the after tax payment basis for DP-EE contributions. Did they fail to mention the attorney is a personal injury attorney moonlighting in Sec. 125-EE benefits?

In addition to calculating EE FICA and payroll tax on the DP premiums, but also for purposes of calculating ER payroll taxes.

Today, someone told me that their attorney said the IRS doesn't like the after tax basis for the employee contribution, that it must be taken as pretax and then imputed income back to the employee. EBIA does not agree. Has anyone else heard anything like this?

[SLuskin]

Definitely not an attorney we use, but he is from the benefits division of Proskaeur Rose, and the broker who brought me in to the client uses him.

I have learned that, just like we have honest differences of opinon here on this board, that the benefits attorneys do too. I also read something that said both approaches are ok.

[LRDG]

QDROphile's observation is correct. While the end result may satisify IRS, it is not the mechanism described in Sec. 125.

My concerns would involve the potential for EE/ER tax calculations being inadvertently based on pre-tax DP premium deduction. With the advanced HRI & Payroll systems available today, one would think it unnecessary to use such a convoluted approach, particularly in light of the mechanism being the 'opposite' of what is described in Sec. 125.

I personally would avoid using that aproach unless it was impossible to do so. IRS in more recent rulings and published opinions, has bowed to the concerns of employers, so it may not be a big IRS concern.

I have first hand experienced involving a simple change in IT staff that resulted in huge compliance problems.

[LRDG]

SLuskin, after giving this more thought, it seems there must be an explanation for the attorney to say IRS prefers pre-tax DP premiums, then imputed income back to EEs. Do you have any indication what the explanation could be?