Since you asked: Can an employer provide surrogacy benefits on a tax-favored basis?

Question

What is the tax status of employer-provided surrogacy/gestational carrier benefits, and can they be provided through an employer’s group health plan?

Answer

Generally, employer-provided surrogacy/gestational carrier benefits are taxable to the employee. They are not typically provided through the employer’s group health plan but rather through a written policy outside of the group health plan. Certain state laws may limit or prohibit surrogacy/gestation carrier contracts.

Medical expense taxation general rule

Most employer-provided benefits paying the expenses for a surrogate/gestational carrier are taxable to the employee. Taxation is based on whether the benefits meet the Internal Revenue Code definition of “medical care,” which includes amounts paid ‘‘for the diagnosis, cure, mitigation, treatment, or prevention of disease, or for the purpose of affecting any structure or function of the body [for the taxpayer, taxpayer’s spouse, or a taxpayer’s dependent.]” Services considered medical care can be excluded from an employee’s gross income.

Most employer-provided surrogacy/gestational carrier expenses are not considered “medical care” because providing services to the surrogate or carrier is not the same as providing those services to the taxpayer (i.e., the employee or his or her spouse or dependents) as the tax code requires.

Several IRS private letter rulings (PLRs) specifically address the tax status of surrogacy expenses. While PLRs are not formal regulations, they do provide insight into how these benefits are taxed:

• PLR 202114001 addressed whether expenses incurred for in vitro fertilization (IVF) procedures and gestational surrogacy constitute tax-deductible medical care under the tax code. The IRS noted that only costs and fees directly attributable to medical care of the taxpayer, the taxpayer’s spouse or the taxpayer’s dependent qualify as eligible medical expenses. Any expenses involving egg donation, IVF procedures and gestational surrogacy incurred for third parties are not incurred for the treatment of disease nor are they for the purpose of affecting any structure or function of the taxpayers’ bodies. While certain expenses are not deductible — egg retrieval, IVF medical costs, the surrogate’s childbirth costs and fees, the surrogate’s medical insurance related to the pregnancy, legal and agency fees for the surrogacy, and other medical costs and fees arising from the surrogacy — a small portion of the costs paid for medical care directly attributable to the taxpayers would qualify as deductible medical expenses (e.g., sperm donation and sperm freezing).
• In PLR 2004-0187 and PLR 2002-0291, the IRS stated that medical expenses paid for a surrogate mother generally would not qualify as a deductible medical expense, as the surrogate mother is not the taxpayer or the taxpayer’s spouse or dependent.

The following court cases also state that certain medical expenses for a surrogate/gestational carrier are not tax-deductible and can’t be excluded from income if paid by an employer:

• Morrissey v. United States. The court found that expenses related to IVF, egg donation and gestational surrogacy incurred by a gay man in an unsuccessful attempt to have a child with his partner do not constitute “medical care” because the procedures did not affect the structure or function of his (i.e., the taxpayer’s) body.
• Magdalin v. Commissioner. The court found that the taxpayer (a medically fertile unmarried man) could not take a medical expense deduction for expenses incurred for IVF, ICSI, egg donation and surrogacy. The taxpayer’s deductions were denied on the grounds that: (1) his inability to conceive did not constitute medical infertility; and (2) the treatments did not affect the structure or function of his body but instead ‘‘affected the structures or functions of the bodies of the unrelated surrogate mothers.’’

Employer group health plan coverage

Employers may cover medical care for surrogate/gestational carriers under their group health plans, but it is not a common practice. Plans typically only cover employees and their tax dependents because those are the individuals who may receive tax-favored benefits. Given that surrogacy/gestational carrier benefits are taxable, most employers provide them outside of their group health plans. Keep in mind that under ERISA, benefits under a group health plan are intended to be for employees and their beneficiaries; therefore, covering non-employees under an ERISA governed group health plan could raise ERISA compliance issues (including potential issues for multiple employer welfare arrangements).

Application of state law

Aside from the tax status of employer-provided surrogacy/gestational carrier benefits, state laws may limit, prohibit or highly regulate the surrogacy/gestational carrier process. This could include limiting compensation in surrogacy contracts, limiting surrogacy to married couples or prohibiting surrogacy contracts entirely. Employers interested in adding surrogacy/gestational carrier benefits should consult their legal counsel.