Minnesota pays IRS penalty — but state workers still face 2025 tax bills for covering ex-spouses

Alpha News previously reported that the State of Minnesota will pay nearly $7 million to the Internal Revenue Service (IRS) after violating federal tax rules tied to an insurance policy that required some state employees to continue covering ex-spouses on their health plans.

The state is footing the bill for back taxes from 2022 through 2024, but employees are still on the hook for 2025.

“We had no choice,” said Kelly O’Leary, a former state employee who retired in 2020, said she was required to keep her ex-husband on her health plan for 16 years.

“Now we, the employees, have to pay the taxes from what the ex-spouses benefited from,” she added.

As of April 1, 2025, no ex-spouses remain on state employee health insurance plans – all were required to be removed by that date. But because the coverage remained in place for the first three months of the year, some current and retired employees are being taxed on the value of that benefit for 2025.

O’Leary said her current husband, also a state worker, removed his ex-spouse from coverage after their divorce. But two years later, he was told by the state that he had to put her back on the plan.

Their experience appears to align with a communication from Minnesota Management and Budget (MMB) to employees: the state followed previous guidance from insurance regulators that required continuing coverage for ex-spouses when children were also covered.

However, MMB later learned they violated federal tax law. The IRS determined that the state should have been offering this coverage on a post-tax basis — not pre-tax basis. This triggered a $6.8 million settlement covering the 2022–2024 tax years.

Workers say communication was unclear, and the tax bills are coming

While current employees will see the taxes deducted from their paychecks over five installments, O’Leary said the process for retirees was not explained.

She received a letter in February informing her that ex-spouses would no longer be covered after March 31, 2025. But it wasn’t until July that she received another letter, this time explaining that they would be taxed for the value of that coverage in 2025.

“I had to email them and ask how this would be done for retirees,” she said.

In response, the state told her she would receive a W-2 in 2025 showing the “imputed income”: the value of her ex-husband’s insurance coverage for January through March, which for O’Leary, totaled $2,648.40. That amount will be added to her taxable income and reflected in her annual return.

“Although you retired in 2020 and did not earn wages in 2025, the imputed income must still be reported and taxed through your annual return,” the state wrote in an email.

O’Leary will not have the option of spreading out tax payments like current employees. Instead, the full amount will come due when she files her taxes next year.

MMB has said the $6.8 million settlement will be paid through agency funds; contributions from departments based on how many ex-spouses were historically covered; and a $2.47 million transfer from the state’s General Contingent Account, that has been approved by Gov. Tim Walz.

MMB also noted that former spouses were offered COBRA continuation coverage — at their own expense — after March 31, while coverage for children would remain unaffected.

Alpha News has reached out to MMB for comment, but did not receive a response.

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