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TAXING QUESTION ON PARTNER BENEFITS

IRS RULES OUT SOME BREAKS

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WASHINGTON-A private letter ruling underscores that federal tax officials likely will not approve tax-free domestic partner health benefits for workers who do not financially support their partners, benefit experts say.

That stance, though, could change if states ever recognize same-sex domestic partners as legal spouses-an issue that promises to draw much attention in many statehouses nationwide over the next year or two as lawmakers await a ruling on the issue from a state court in Hawaii.

If Hawaii recognizes same-sex marriages, other states may have to legally recognize the marriages of same-sex couples married there.

In the meantime, the Internal Revenue Service ruling is a reminder to employers that are considering offering domestic partners coverage that they first should consider the tax, administrative and communication issues that are involved in providing the benefits.

The ruling, though, likely will have little bearing on the few employers that already offer the benefits, experts said. Hewitt Associates L.L.C. of Lincolnshire, Ill., estimates that 250 companies offer the benefits.

The IRS sent the ruling last Oct. 18 to the employer that sought the guidance, but the Treasury Department released it publicly last week.

Private letter rulings are not meant to set precedent for all employers, but the letters do indicate how the IRS views a tax issue. The latest domestic partners tax ruling is the fifth on this issue, and all are comparable, experts say.

In its ruling for an unidentified law firm, the IRS notes that employees can treat domestic partners coverage as a tax-free benefit if their partners lived with them throughout the year and received more than half of their financial support from the employee.

But, in situations where employees' partners are self-supporting, the IRS will require the employees to declare as taxable income the value of the domestic partner health coverage that their employers provide.

Employees with legal spouses are not taxed on the value of health benefits that their employers provide to the spouses, regardless of whether the spouses are self-supporting.

Even unmarried opposite-sex couples who have lived together for many years enjoy the same tax treatment in states that recognize common-law marriages, pointed out Chip Kerby, a principal in the Washington Resource Group at William M. Mercer Cos. Inc.

Thirteen states and the District of Columbia recognize common-law marriages.

The IRS acknowledged in its latest ruling that this tax treatment may be inequitable. But, the agency noted, Section 152 of the Internal Revenue Code requires the IRS to defer to state laws on marital status issues.

No state currently recognizes same-sex relationships as legal marriages.

But, under a 1993 Hawaii Supreme Court decision, a trial court must decide whether the state Legislature has a "compelling" reason to prohibit local authorities from issuing marriage licenses to same-sex couples. In response to the ruling, the Hawaii Legislature barred same-sex marriages in 1994, stating that marriage is "intended for the propagation of the human race by man/woman units."

But, commitment and choice, not procreation, are the basis of civil marriage rights under standards that the U.S. Supreme Court has set, said the Lambda Legal Defense & Education Fund Inc., a New York-based gay- and lesbian-rights organization.

Others, though, say the high court has linked marital rights with the right to procreate.

If the Hawaii court recognizes same-sex unions as legal marriages, "common sense, constitutional doctrines and legal precedent suggest" other states will have to recognize at least the same-sex marriages that Hawaii recognizes, according to Lambda.

Lambda expects the Hawaii court to begin hearing the case in July.

There already is a legislative backlash in several states against the case.

Perhaps most notably, the California Legislature is considering a measure, A.B. 1982, that would block the state from recognizing same-sex marriages that other states recognize.

Utah enacted a similar law last year. A comparable bill in South Dakota died last year and likely will meet the same fate this year. The Senate tabled it last week.

In Alaska, in response to a 1995 state Supreme Court ruling that an employer's benefit plan cannot discriminate between same-sex and opposite-sex couples, the Legislature is considering a bill that would clearly state that Alaska recognizes only marriages between men and women. That distinction was muddled during the 1970s when the state's statutes were "gender-neutralized," said a spokeswoman for the bill's sponsor, state Rep. Norman Rokeberg, R-Anchorage.

The Alaska bill does not clearly address whether the state would not recognize same-sex marriages that other states recognize.

Regardless of state action, there likely will be a moderate increase in the number of employers that offer domestic benefits, Mercer's Mr. Kerby predicted. Those employers will be compelled to offer the benefits either because competitors do or their employees demand them, he said.

In cases involving common-law marriages or if some states do recognize same-sex marriages, multistate employers could face some administrative burdens in determining whether domestic partner benefits should be treated as taxable income.

"Most employers tend to not want to get involved in any real examination or analysis of this issue," Mr. Kerby said. Employers that offer domestic partner coverage typically ask employees to decide how the employer should treat the benefit for tax withholding purposes, he said.

Ultimately, though, "this is really a personal tax matter," observed Dennis Coleman, a principal with Kwasha Lipton in Fort Lee, N.J. "This is going to be a deductible expense for the employer one way or the other."

Apple Computer Inc. of Cupertino, Calif., which began offering domestic partner benefits several years ago, treats them as taxable income, said Sally Brewster, benefits manager.

"Most of the time it is not going to be deductible, so we wouldn't want to get into requesting documents to determine whether it is or isn't," she explained.

"I'm not even sure what documents we can get to prove it one way or the other, and we certainly don't want to look at people's personal income tax filing" to determine if an employee financially supports a partner.