A new California law - the Same Sex Couple Tax Fairness Act (the Act) - provides a temporary personal income tax (PIT) exclusion for any amounts received by an employee in a registered same-sex domestic partnership from an employer to compensate for additional federal income taxes the employee incurs on employer-provided accident and health care benefits. The exclusion also applies to any amount of the employer-provided compensation paid to an employee that represents the grossed-up amount that an employer includes to offset additional federal income taxes incurred on the compensation.
The new exclusion is effective immediately and applies for tax years beginning on or after January 1, 2013, and through December 31, 2018.
An employee may incur additional federal income taxes on these benefits because the same-sex domestic partner of the employee is not considered the employee's "spouse" under the recent revenue ruling issued by the Internal Revenue Service (IRS) implementing the Supreme Court's decision regarding same-sex marriage in United States v. Windsor. In addition, the temporary exclusion extends to grossed-up amounts because many California employers use a special gross-up calculation to offset the additional federal income tax incurred on such compensation. If an employer does not use that calculation, employees in domestic partnerships will incur a substantial amount of additional taxes.
In California, federal income tax paid by an employer on an employee's behalf is normally included in the employee's taxable wages for purposes of withholding California personal income tax (PIT). However, since January 1, 2002, accident and health insurance provided by an employer to an employee's same-sex registered domestic partner and to their dependents has been excluded from California PIT. But, before the Act, amounts reimbursed by an employer to an employee for the federal income tax incurred on these benefits was not excluded from California PIT.
In addition, according to the California Franchise Tax Board (FTB), the IRS revenue ruling aligns the federal and California income tax filing status of legally married same-sex couples. Accordingly, the FTB says same-sex married couples do not have to prepare a federal income tax return before preparing their California joint income tax return.
However, because the IRS ruling does not apply to them, California-registered domestic partners must still claim the filing status of married filing jointly, or married filing separately for California income tax purposes but may not do so for federal income tax purposes. Consequently, registered domestic partners must continue to prepare a federal income tax return before preparing their California income tax return.