December 13, 2013

If an employer extends benefits to same-sex partners and the children of same-sex partners, then the employer needs to address how it will value those benefits if the same-sex partner (or the child of the same-sex partner) is not a tax dependent under the Internal Revenue Code.

A. Federal Income Tax and the Definition of Dependent

Section 1521 of the Internal Revenue Code defines who is a dependent for purposes of federal tax law. Section 105(b)2 modifies the definition under section 152 of who is a dependent for purposes of health benefits. Section 105(b) removes the following portions of section 152’s definition of a qualifying relative:

• Provision that an individual who is a dependent shall be treated as having no dependents (in essence, disregarding section 152(b)(1)).
• Provision that an individual who files a joint tax return with a spouse is not a dependent (in essence, disregarding section 152(b)(2)).
• Provision that an individual is not a qualifying relative if the individual has gross income that is less than the exemption amount (in essence, disregarding section 152(d)(1)(B)).3

A qualifying relative (as modified by section 105(b)) has the following requirements:4

• Relationship – An individual other than a spouse who has the same principal place of abode as the employee and is a member of the employee’s household.5
   - The same principal place of abode is fairly straightforward.
   - To be a member of the employee’s household, the relationship must not violate local law.

• Support – An individual for whom the employee provides most of the support (over onehalf of the support) for the year.6
   - All sources of support are considered.
   - An individual’s own funds are not support unless actually spent.

• Not a qualifying child.7

• Must be a U.S. citizen, a U.S. national, or resident of Canada or Mexico.8

A qualifying child (as modified by section 105(b)) has the following requirements:9

• Relationship – A child or stepchild of the employee (including adopted and foster children) who has not attained age 27.10

• Must be a U.S. citizen, a U.S. national, or resident of Canada or Mexico.11

B. State Income Tax

State income taxes, not surprisingly, vary from state to state. Some states have an income tax while others do not. The vast majority of those with an income tax generally follow the Internal Revenue Code, including its definition of who is a tax dependent. However, if the  state recognizes same-sex marriage, civil unions, or domestic partners, then the value of benefits provided to a same-sex partner would not be included in income for purposes of state income tax.

• States Where State Income Tax Generally Follows Federal Income Tax and State Does not Recognize Same-Sex Partners of Any Type

If the state income tax law generally follows the Internal Revenue Code (including the definition of dependent under section 152 as modified by section 105(b)), then the employer will need to impute income to an employee if a same-sex partner (or a child of the same-sex partner) is not a tax dependent.

• States Where State Income Tax Does Not Follow Federal Income Tax and State Does Not Recognize Same-Sex Partners of Any Type

If the state income tax law does not follow the Internal Revenue Code (including the definition of dependent under section 152 as modified by section 105(b)), then the employer will need to determine who is eligible for tax-favored treatment with respect to benefits provided by an employer (in essence, who is a tax dependent for purposes of  state income tax law). Once the employer makes this determination, the employer will need to impute income to an employee if a same-sex partner (or a child of the same-sex  partner) is not a tax dependent for state income tax law purposes.

• States Where State Income Tax Follows Federal Income Tax and

State Recognizes Some Same-Sex Partners In this situation, there are possibly two manners in which the same-sex partner qualified for tax-favored treatment under state income tax law. The first would be if the same-sex partner satisfies the definition of dependent under section 152 as modified by section 105(b) of the Internal Revenue Code. If so, no further inquiry is necessary because the state income tax law follows federal income tax law

The second is if the same-sex partner qualifies for tax-favored treatment based on their status under state law. For example, if the state income tax law or guidance specifically accords tax-favored treatment to same-sex spouses and the employee’s same-sex partner  is a same-sex spouse, then the employer can determine whether the same-sex partner satisfies the state requirements. Similarly, if the state income tax law or guidance specifically accords tax-favored treatment to domestic partners and the employee’s samesex partner is a domestic partner, then the employer can determine whether the same-sex partner satisfies the state requirements.

If the same-sex partner satisfies either approach, then the same-sex partner qualifies for  tax-favored treatment under state income tax law.

NOTE: One difficulty that may arise is which types of same-sex partners may be afforded tax-favored treatment under state law. For example, suppose an employee lives in New Jersey and is in a civil union (as permitted under New Jersey law) but the employee works in New York. New York law provides tax-favored treatment to  samesex spouses.12 New York, however, does not provide for tax-favored treatment to samesex  partners in a civil union. Thus, unless the same-sex partner who lives in New Jersey is a tax dependent for purposes of the Internal Revenue Code, the same-sex partner would not receive tax-favored treatment under New York state law and the employer would need to impute income for the value of employer-provided benefits the employee receives for the same-sex partner.

• States Where State Income Tax Does Not Follow Federal Income Tax and

State Recognize Same-Sex Partners of Any Type  In this situation, the employer will need to determine if the state income tax law or guidance specifically accords tax-favored treatment to a same-sex spouse, partner in a  civil union, or domestic partner (or all of these), or if the same-sex partner qualifies as a tax dependent under state income tax law. If the state income tax law does not follow the
Internal Revenue Code (including the definition of dependent under section 152 as modified by section 105(b)), then the employer will need to determine who is  eligible for tax-favored treatment with respect to benefits provided by an employer (in essence, who is a tax dependent for purposes of state income tax law). Once the employer makes this determination, the employer will need to impute income to an employee if a same-sex partner (or a child of the same-sex partner) is not a tax dependent for state income tax law purposes.

• States with No State Income Tax

The absence of an income tax means the employer is able to avoid doing an analysis of the state income tax rules. States with no income tax include: Alaska, Florida, Nevada, New Hampshire, South Dakota, Tennessee, Texas, Washington, and Wyoming.13

About the Authors:

Havilah Gebhart

• Attorney at Dorsey & Whitney LLP
• Advises employers on retirement plans, welfare plans and executive compensation
• Focuses on health plans and health care reform (Affordable Care Act)
• Can be contacted at 612-492-6078 or [email protected]

Tim Goodman

• Partner at Dorsey & Whitney LLP
• Advises employers on health plans, health care reform (Affordable Care Act), wellness programs, retirement plans and executive compensation
• Advises employers on DOL, IRS and EEOC guidance, responding to benefit claims, executive employment agreements and severance, and assisting on benefit matters
• President of the Midwest Pension Conference
• Former president of the Minneapolis Pension Council
• Member of the American Bar Association’s Tax and Labor and Employment Sections
• Member of the Minnesota State Bar Association’s Employee Benefits Section and Tax Section
• Can be contacted at 612-340-2825 or [email protected]

Jamison Klang

• Attorney at Dorsey & Whitney LLP
• Advises employers on retirement plans, welfare plans and executive compensation
• Focuses on equity compensation issues and nonqualified deferred compensation arrangements
• Can be contacted at 612-492-6083 or [email protected]

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1 See 26 U.S.C. § 152 (2006).
2 See 26 U.S.C. § 105(b) (2006).
3 See 26 U.S.C. § 105(b) (2006).
4 See 26 U.S.C. § 152(d) (2006) (defining qualifying relative); 26 U.S.C. § 105(b) (2006).
5 See 26 U.S.C. § 152(d)(2)(H) (2006).
6 See 26 U.S.C. § 152(d)(1)(C) (2006).
7 See 26 U.S.C. § 152(d)(1)(D) (2006).
8 See 26 U.S.C. § 152(b)(3) (2006).
9 See 26 U.S.C. § 152(c) (2006) (defining qualifying child); 26 U.S.C. § 105(b) (2006).
10 See 26 U.S.C. § 152(c)(2) (2006). See also 26 U.S.C. § 105(b) (providing expenses for children who have not attained age 27 are eligible, effectively disregarding the age limitations under section 152(c)(3)).
11 See 26 U.S.C. § 152(b)(3) (2006).