Ok, after a quick search, I found that if you put an extra set of brackets around the \cite{}, then the highlighting should work!!
So for example,
\hl{{\cite{citation}}}
It should work for other citation types too, \citeyear, etc. I haven't tried it, but it probably works for other environments.
http://tex.stackexchange.com/questions/20021/how-to-highlight-paragraph-linebreak-preserving-as-well-as-itemize-tabular-et
Here is a screen shot from me:
Very helpful solution, thanks !!!
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