Ernst & Young LLP issued a tax alert explaining that recently enacted legislation will temporarily exclude from California personal income tax (PIT) the amount of federal income tax that employers pay for health insurance benefits provided to employees who are a member of a registered domestic partnership.
The law is effective immediately and applies for taxable years beginning on or after January 1, 2013 and through December 31, 2018. (AB 362, signed by the governor on October 1, 2013.)
Under all other circumstances, federal income tax paid by employers on behalf of their employees generally is included in wages subject to California PIT.
For the definition of a registered domestic partner see: https://www.ftb.ca.gov/individuals/faq/dompart.shtml
Since January 1, 2002, employer-provided accident and health insurance provided to the domestic partner of an employee (and that partner’s dependents), along with several other benefits, has been excluded from California gross income (Revenue and Taxation Code section 17021.7)
Prior to the passage of AB 362, an amount reimbursed by an employer to the employee for the federal income tax incurred on these benefits was not excluded from California PIT.
Employer payment of federal income tax under the new law
Assembly Bill 362, the Same Sex Couple Tax Fairness Act, excludes from California gross income any amounts received by an employee from an employer to compensate for additional federal income taxes that are incurred by the employee on employer-provided health-care benefits because, for federal income tax purposes, the domestic partner of the employee is not considered the spouse of the employee.
The exclusion from gross income also applies to any amount of the employer-provided health-care compensation paid to an employee that represents the “grossed-up” amount that an employer includes to offset additional federal income taxes incurred on such compensation.
According to new Revenue and Taxation Code Section 17141:
“Gross income shall not include any amount received by an employee from an employer to compensate for the additional federal income tax liability incurred by the employee because, for federal income tax purposes, the same-sex spouse or domestic partner of the employee is not considered the spouse of the employee under Section 105(a) or Section 106(a) of the Internal Revenue Code, including any compensation for the additional federal income tax liability incurred with respect to those amounts.”
The Act was introduced to the California state legislature on February 14, 2013, months before the US Supreme Court Windsor decision that overturned section 3 of the Defense of Marriage Act (DOMA) and allowed same sex married couples the same tax break on a federal level as opposite sex married couples. It was intended to cover both same sex married couples and those involved in a domestic partnership. As a result, the Act has a lesser impact than originally intended by the bill’s author.
Impact of the new law on California same-sex partner benefits
According to Forbes, (http://www.forbes.com/sites/hbsworkingknowledge/2013/06/26/how-overturning-doma-will-benefit-businesses), as of the date of the Supreme Court decision, 38 US companies used the gross up calculation to cushion employees from the unequal federal income tax rules applicable to for employer provided same-sex partner benefits. The California senate summary for AB 362 states that 71 California companies use the gross up method for this purpose.
It’s been estimated that employees working for companies that provided same sex benefits, but did not gross up, incurred an average of $1,069 extra taxes per year—possibly more if the partner’s dependents were also included in coverage.
Correcting 2013 wages and PIT for active employees
For active employees, employers should immediately adjust 2013 California PIT taxable wages using one of the methods below:
(1) Refund or credit the overpaid PIT for the previous nine months to affected employees prior to December 31, 2013 and file adjusted quarterly tax returns with the Employment Development Department (EDD)
(2) Don’t refund or credit overpaid PIT for the previous nine months, but inform employees that the law change may result in a California PIT refund on their personal income tax returns.
Regardless of the approach an employer takes, the 2013 Form W-2, box 16 must reflect the correct amount of California taxable wages.
According to an EDD representative, employers must first credit or refund the overwithheld amount to the employee during the current 2013 calendar year. Then, the employer should file Form DE 9ADJ, Quarterly Contribution and Wage Adjustment for each affected quarter to claim a credit or refund of the overpaid amount.
The EDD also recommends that employers require employees to sign a statement indicating that the overwithheld PIT has been credited or refunded. The employer must complete box 2 of the Form DE 9ADJ indicating that the overpaid amount has been refunded to the employee and that the amount to be credited will not be reflected on the Form W-2.
Form DE 9ADJ can be found at http://www.edd.ca.gov/pdf_pub_ctr/de9adj.pdf.
Correcting 2013 wages and PIT for terminated employees
According to the Form DE 9ADJ instructions, an employer may claim a credit or refund of PIT overwithheld from an employee’s wages when the excess amount is credited or refunded to the employee during the same calendar year and the excess amount is not shown on the Form W-2 issued to the employee.
An employer that has already issued the 2013 Form W-2 to employees should not refund the PIT overwithholding nor change the PIT withholding amount on the Form W-2.
The employee will receive a credit when the California Resident Income Tax Return (Form 540) is filed with the California Franchise Tax Board.
Employers must adjust the California state wages for calendar year 2013 on Form W-2 (box 16).
Ernst & Young LLP insights
Employers should be aware that the law applies only to California gross income, and does not affect the rules applicable to taxes imposed under other laws, or in other jurisdictions.
Employers that gross up domestic partner benefits and reimburse employees for the additional federal income tax incurred due to coverage of a domestic partner must still include these amounts as federal taxable wages on Form W-2.
Federal legislation has been introduced for consideration that would extend the definition of marriage to include individuals and their dependents who are a member of a registered domestic partnership, civil union, or similar arrangement recognized under state law. (SB 729/HR 2499, the Tax Parity for Health Plan Beneficiaries Act of 2013)