Federal tax law allows for tax-free employer-provided health care coverage. Your employer-provided health insurance is a tax-free benefit. This is unlike other benefits that you may receive from your employer – such as a health and fitness subsidy, which is taxable.
Employer-provided health care for your spouse and children are also tax-free. However, health care coverage provided to domestic partners is not tax-free.
What is a Domestic Partner?
Wikipedia explains domestic partnership:
. . . an interpersonal relationship between two individuals who live together and share a common domestic life but are not married (to each other or to anyone else).
Domestic partnership is commonly used to to refer to members of the lesbian, gay, bi-sexual and transgender (LGBT) community. However, when it comes to your employer’s benefit package, domestic partner can also include heterosexual live-in boyfriends and girlfriends, as well as heterosexual live-in betrotheds.
Taxation of Health Insurance Benefits for a Non-Spouse
If you include your domestic partner (be they LGBT or heterosexual) on the health insurance plan provided by your employer, be prepared to pay the consequences: the tax consequences. Opting for employer-provided health insurance on your domestic partner means being taxed on the value of the health insurance plan that your employer pay for. Consider an example from our favorite fictional Big Four employee, Joe Danger, CPA:
Joe Danger, CPA has been living with his girlfriend for years. Fearing that his girlfriend will be fined under the Affordable Care Act for not having her own health insurance, Joe adds his girlfriend to his health insurance policy provided by his employer. Come tax season, Joe receives a W-2 stating his income of not just his salary of $100,000 – but $105,000.
The additional $5,000 of “income” comes from the value of the health insurance that his girlfriend received. Health insurance received for a domestic partner is a taxable benefit. Given the example above, Joe is looking at a tax liability well in excess of $1,000.
Planning for Taxes on the Health Insurance Benefits of a Non-spouse
If you know that you’ll be adding a domestic partner to your health coverage, consider a couple strategies to help prepare you for the additional tax liability:
• Increase Your Tax-withholdings: You may be able to update your W-4 to increase your tax-withholdings. The increased withholding can help to net out the additional tax liability created by domestic partner health coverage.
• Create a segregated savings account for the larger-than-usual pending tax bill: Make a new bank account, and automate deposits into the account to coincide with the deposit of each paycheck. While this process helps avoid the requirement of filling out paperwork with the human resources department (i.e. update your W-4), it does require a little discipline. The challenge will be to resist the temptation to raid the account – the same discipline you need to use with your emergency fund.