Another Tax Trap: Imputed Income in Divorce Settlements, Part 1

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Hi there,

April 15th is creeping up on us. I find doing my taxes while its snowing, AGAIN, a real insult.

This week and next week’s post were written by my terrific colleagues, Ron Barriere and Jen Green. They highlight a tricky complexity in the new health insurance laws for divorcing couples.

Best,

Nancy

Divorcing spouses have many issues to consider in negotiating the terms of a divorce agreement. One of the seemingly “easier” issues for divorcing spouses and their counsel is health insurance. While the issue of health insurance coverage is typically included within the divorce agreement, the federal tax implications are often overlooked. Recent interpretations of federal tax law underscore the need for divorcing spouses to use skilled divorce counsel and tax practitioners in negotiating the terms of their divorce agreements.

It is commonplace for a divorce agreement to contemplate one spouse continuing to provide health care coverage through his/her employment for an ex-spouse. Under the Affordable Care Act (ACA or “Obamacare”), the IRS will require reporting by the employer of the cost of such coverage of employer-sponsored insurance. In some instances, the reporting requirement may facilitate the apportionment of the cost of health coverage for divorced spouses. However, the insuring spouse must be forewarned of the possibility of being subject to tax on imputed income based on the fair market value of the insurance benefits being provided to his/her ex-spouse.

The likelihood of this imputation varies greatly from employer to employer, such that divorce counsel often cannot state with certainty whether or not an employee who continues to carry the health care coverage of his/her former spouse will in fact be subject to tax on imputed income. Therefore, it is extremely important to be cognizant of this issue and plan for the possibility of imputed income for continuing health care coverage of a former spouse. Following is a brief discussion of how imputed income works in connection with continuing health care coverage of a former spouse.

Under the Internal Revenue Code, employer-provided health insurance is typically considered a nontaxable fringe benefit to the employee. However, this exclusion only applies to coverage of the employee and the employee’s spouse, dependents, and children up to a certain age. It does not apply to the employee’s former spouse. The IRS views the health care coverage of a former spouse as a taxable fringe benefit to the employee, notwithstanding the fact that the former spouse may in fact be the one who pays for any additional coverage costs. The IRS has taken the position that the “fair market value” of health insurance benefits provided to a person who is not an employee’s spouse or dependent must be “imputed” to the employee and included in his/ her federal gross income.

The crux of this situation lies in the determination of the “fair market value” of the employer-provided health insurance benefits. This amount could vary greatly from employer to employer, depending on how much the employer provides for coverage. The income imputed to the employee is the value of the benefit provided by the employer, excluding the benefit paid for that employee.

In our next post we will explore how different employers and human resource departments are arriving at their calculations, and how divorcing spouses should consider imputed income in divorce agreements.

Topics:  Deadlines, Divorce, Healthcare, Income Taxes, IRS

Published In: Family Law Updates, Tax Updates

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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