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. Below 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, employerprovided 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.

With most Massachusetts health insurance  plans, provided he/she has not yet  remarried, an employee with at least one  dependent child can add a former spouse to  the coverage for no additional cost, so there  is no additional cost to the employer either.  In these situations, one would presume that  no income should be imputed to the  employee because the employer is not  required to pay the insurer any additional  premium for the benefit of continuing  coverage of a former spouse. Unfortunately,  not all human resource departments  share this view. Some human resource  departments are deciding that the former  spouse is receiving a benefit that is equal to  the value of the employee’s own individual coverage and, thus, are imputing the fair  market value of that coverage to the  employee on his/her Form W-2.  

Other human resource departments are  imputing the income to the employee by  dividing the entire employer benefit  amongst the family members in order to  determine the fair market value of the  benefit to the former spouse. For example,  if a family plan costs the employer $100  per week and the former spouse is one of  four people covered, some human resource  departments would impute income of $25  per week ($100/4) to the employee as the  fair market value of health care coverage  of the former spouse. In neither scenario  does the “fair market value” bear any  relation to any real cost incurred by  the employer. 

Because of the discretionary nature of the  imputation, many employees find  themselves having to argue and plead  their cases on an individual basis to  human resource personnel or employers  to not impute income to them (with  varying degrees of success). Worse still,  some employees do not even realize that  income is being imputed to him/her until  the following year when he/she sees it on  his/her Form W-2.  

Until federal tax laws set clearer guidelines  as to how to apply the fair market value of  the continued health insurance coverage of  a former spouse, divorcing spouses should  be mindful of this issue when providing for  continuing health care coverage of a former  spouse. Divorcing spouses and their counsel  should include specific language in divorce  agreements to plan for the possibility of  imputed income after consultation with a  tax professional, including a determination  of who will have the burden of the economic  and tax cost of continuing insurance  coverage. Failure to take this issue  into consideration at the outset could result  in unexpected consequences to both  divorcing spouses.