Directive 09-2: Personal Income Tax Treatment of Employer-Provided = Health=20 Insurance Coverage for an Employee's Former Spouse

Introduction: This Directive follows TIR 07-16, Personal = Income Tax=20 Treatment of Employer-Provided Health Insurance Coverage for an = Employee=E2=80=99s=20 Child, in discussing another area where Massachusetts insurance statutes = require=20 employer-provided health insurance coverage for individuals who are not = the=20 spouse or dependent of an employee as defined for purposes of the = exclusion of=20 the benefit from gross income under =C2=A7 106 of the Internal Revenue = Code.

Issue: If federal imputed income results from the = legally=20 required provision of health insurance coverage to an employee=E2=80=99s = former spouse,=20 may that income be deducted from Massachusetts gross income under G. L. = c. 62, =C2=A7=20 2(a)(2)(Q)?

Directive: For taxable years beginning on or = after=20 January 1, 2007, to the extent that the coverage is required under = Massachusetts=20 statutes such as G. L. c. 176G, =C2=A7 5A, any federal imputed income = that results=20 from the provision of health insurance coverage to an employee=E2=80=99s = former spouse=20 may be deducted from Massachusetts gross income under G. L. c. 62, = =C2=A7=20 2(a)(2)(Q).

Discussion:

Federal Income Tax

Section 61(a)(1) of the Internal Revenue Code (the Code) states that, = except=20 as otherwise provided, gross income includes compensation for services,=20 including fees, commissions, fringe benefits, and similar items. A = fringe=20 benefit is any property or service that an employee receives in lieu of = or in=20 addition to regular taxable wages. The extent to which a = particular fringe=20 benefit is excluded from gross income depends on the Code provisions = that apply=20 to the benefit.

Employer-provided health insurance coverage is a fringe benefit.=20 Section 106(a) of the Code provides that gross income of an = employee does=20 not include employer-provided coverage under an accident or health plan. = Section 1.106-1 of the U.S. Treasury Regulations expands the = exclusion by=20 providing:

The gross income of an employee does not include contributions = which his=20 employer makes to an accident or health plan for compensation (through = insurance or otherwise) to the employee for personal injuries or = sickness=20 incurred by him, his spouse, or his dependents, as defined in section = 152.

In addition, for purposes of the exclusion at Code =C2=A7 106 for=20 employer-provided health coverage, Internal Revenue Service Notice = 2004-79,=20 2004-2 C.B. 898, has expanded the definition of dependent at Code =C2=A7 = 152 to=20 eliminate the gross income limit at Code =C2=A7 152(d)(1) for a = =E2=80=9Cqualifying=20 relative=E2=80=9D. The Internal Revenue Service has further = allowed the=20 exclusion from gross income for employer-provided health coverage for = retired or=20 laid-off employees, their spouses and dependents and for the surviving = spouses=20 or dependents of deceased employees as an extension of the = regulations. =20 See e.g., Rev. Rul. 82-196, 1982-2 C.B. 53, and Rev. Rul. 85-121, = 1985-2=20 C.B. 57.

On August 6, 2007, the Internal Revenue Service issued new proposed=20 regulations providing guidance on cafeteria plans under section 125 of = the=20 Code. The proposed regulations generally indicate that they apply = on and=20 after plan years beginning on or after January 1, 2009. Section=20 1.125-1(h)(2) and (3) of the proposed regulations specifically addresses = the tax=20 treatment of health coverage purchased for someone other than the = employee=E2=80=99s=20 spouse or dependents. It provides as follows:

If the requirements of section 106 are satisfied, employer-provided = accident and health coverage for an employee and his or her spouse or=20 dependents is excludible from the employee=E2=80=99s gross = income. The fair=20 market value of coverage for any other individual, provided with = respect to=20 the employee, is includible in the employee=E2=80=99s gross = income. =C2=A7 1.106-1; =C2=A7=20 1.61-21(a)(4), and =C2=A7 1.61-21(b)(1). A cafeteria plan is = permitted to=20 allow employees to elect accident and health coverage for an = individual who is=20 not the spouse or dependent of the employee as a taxable = benefit.

* * * * = * =20 * * * * * =20 * * * * * =20 * * * * *. = * =20 * * * * * = * =20 *

Example. Accident and health plan coverage for individuals = who are=20 not a spouse or dependent of an employee. (i) Employee = C=20 participates in Employer M=E2=80=99s cafeteria plan. Employee C = timely elects=20 salary reduction for employer-provided accident and health coverage = for=20 himself and his former spouse. C=E2=80=99s former spouse is not = C=E2=80=99s=20 dependent.

(ii) The fair market value of the coverage for the former spouse is = $1,000. Employee C has $1,000 includible in gross income for the = accident and health coverage of his former spouse, because the section = 106=20 exclusion applies only to employer-provided accident and health = coverage for=20 the employee or the employee=E2=80=99s spouse or = dependents.

Proposed Treas. Reg. =C2=A7 1.125-1(h)(2) and (3).

Valuation of Imputed Income is a Question of Federal Law. = For=20 federal income tax purposes, an employee whose employer-provided health=20 insurance covers a former spouse who is not a dependent of the employee = will be=20 taxed on the fair market value of the former spouse=E2=80=99s coverage = to the extent=20 that it exceeds any amount paid by the employee on an after-tax basis = (employee=20 pre-tax contributions are considered to be employer contributions). = An=20 employer will determine the amount of imputed income attributable to the = health=20 insurance coverage of an employee=E2=80=99s former spouse under = valuation principles=20 articulated in federal income tax law.

MassachusettsPersonal Income Tax

Massachusetts gross income is federal gross income, as defined under = the=20 Code, with certain modifications. G.L. c. 62, =C2=A7 2(a). Generally, = with respect to=20 the personal income tax, Massachusetts adopts the Code as amended and in = effect=20 on January 1, 2005. G.L. c. 62, =C2=A7 1. Massachusetts follows IRC = =C2=A7 106 as amended=20 and in effect on January 1, 2005, whereby employer-provided health and = accident=20 premiums are excluded from the gross income of an employee, as long as = the=20 benefits are for the employee, the spouse or the dependents of the = employee,=20 which terms have been expanded as described above.

Since the value of employer-provided health insurance benefits for an = employee=E2=80=99s former spouse who is not the employee=E2=80=99s = dependent may be included in=20 the employee=E2=80=99s federal gross income under IRC =C2=A7 106, in the = absence of other=20 provisions, it would likewise be included in the employee=E2=80=99s = Massachusetts gross=20 income because Massachusetts follows the Code. G. L. c. 62, =C2=A7 = 2(a).

Effective for taxable years beginning on or after January 1, 2007, = General=20 Laws chapter 62, =C2=A7 2(a)(2)(Q) provides that=20 the following item must be deducted from Massachusetts gross = income:

If an employee participates in an employer-provided health = insurance plan,=20 any amount which, but for this section, would be included in gross = income of=20 the employee by reason of coverage under the plan of any person other = than the=20 employee, to the extent such coverage is mandated by=20 law.

Massachusetts insurance laws traditionally have required = employer-provided=20 health insurance plans to cover former spouses of employees under = various=20 circumstances. For example, G. L. c. 176G (Health Maintenance=20 Organizations), =C2=A7 5A provides:

(a) In the event of the granting of a judgment absolute of = divorce or=20 of separate support to which a member of a group health maintenance = contract=20 is a party, the person who was the spouse of said member prior to the = issuance=20 of such judgment shall be and remain eligible for benefits under said=20 contract, whether or not said judgment was entered prior to the = effective date=20 of said contract, without additional premium or examination therefore, = as if=20 said judgment had not been entered; provided, however, that such = eligibility=20 shall not be required if said judgment so provides. Such = eligibility=20 shall continue through the member=E2=80=99s participation in the = contract until the=20 remarriage of either the member or such spouse, or until such time as = provided=20 by said judgment, whichever is earlier.

(b) In the event of the remarriage of the member referred to in = paragraph=20 (a), the former spouse thereafter shall have the right, if so provided = in said=20 judgment, to continue to receive benefits as are available to the = member, by=20 means of the addition of a rider to the family contract or the = issuance of an=20 individual contract, either of which may be at additional premium = rates=20 determined by the commissioner of insurance to be just and reasonable = in=20 accordance with the additional insuring risks = involved.

For other examples, see, e. g., G. L. c. 32A, =C2=A7 11A, c. = 175, =C2=A7=20 110, c. 176A, =C2=A7 8F and c. 176B, =C2=A7 6B.

Thus, because Massachusetts insurance laws such as G.L. = c. 176G, =C2=A7=20 5A(a) require continued health insurance coverage for a former spouse of = an=20 employee with employer-provided health insurance until the remarriage of = either=20 person unless the judgment of divorce provides otherwise, for taxable = years=20 beginning on or after January 1, 2007, G.L. c. 62, =C2=A7 2(a)(2)(Q) = operates in all=20 such cases to deduct from Massachusetts gross income any gross income = imputed=20 federally. The deduction from Massachusetts gross income under = G.L. c. 62,=20 =C2=A7 2(a)(2)(Q) also applies to employees with coverage under = self-funded or=20 self-insured employer-provided health plans adopting health insurance = coverage=20 of a former-spouse otherwise required for insured plans under the = applicable=20 Massachusetts insurance statutes.

/s/Navjeet K. Bal
Navjeet K. = Bal
Commissioner of=20 Revenue

NKB:MTF:em

April 23, 2009

DD 09-2

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