Tax My Benefits? The Devil in the Details

Taxing everyone’s health care benefits seems to be a back in vogue.  But it is also a reality for some right now.  One of those situations can help us understand the real implications of taxing health care benefits.

Small Businesses

Many small businesses are acutely aware of the inequity in the tax code when it comes to health care.  A small business that files as an individual entrepreneur, files an individual return.  Like you and me, he or she must meet the 7% test.  Only health care costs that exceed 7% of adjusted gross income are exempt from taxation.  For most people with decent employer sponsored health care, that’s a tough threshold to meet.

For small businesses, it means that the they are paying taxes on the 7% of their income that they pay for health care.

But there is another even more relevant example of wage earners who pay taxes on their benefits.

Domestic Partner

As a consequence of the Defense of Marriage Act, the IRS under the Bush Administration approved regulations on the taxation of health care benefits for domestic partners.  I will let others, like the Human Rights Campaign, take up the issue of the inequity of a tax that clearly entitles a married spouse to tax free benefits, but an unmarried spouse (same or opposite gender) is not.
Instead I want to use their situation as a warning for the rest of us when policy wonks start talking about taxing benefits.

The Human Rights Campaign offers the following example of a low wage worker (by DC standards) who adds a domestic partner to his or her coverage.

Human Rights Campaign

Human Rights Campaign

For this individual it is a 50% increase in taxes.  Are politicians serious about a 50% increase in taxes for someone earning $32,000 per year.  Not included in this example or the next example is the extra tax burden on the employer.  When benefits become taxable, the employer is required to pay the employer portion of FICA taxes or 7.65% of the value of the benefits.

At our plan, I used a real example to pose a similar example, plugging real numbers into our QuickBooks payroll module.

Our employee is withholding considerably more in taxes, so the percentage increase is less.  But $2,482 is real money.  $48 per week is real money.  What are politicians thinking or smoking?

Our Plan Example
Our Plan Example

Caution – Entering Wonk Territory

These examples illustrate the conservative point of view that the tax exclusion for employee benefits costs the US Treasury lots of money.  But they do not go nearly far enough to illustrate the added burden on wage earners if employee benefits were  taxed.  The tax on domestic partner benefits only taxes the additional value of adding the domestic partner to the plan.  

The astute reader may have noticed that the imputed income is calculated differently in the two examples.  These methods are both permitted by the IRS which has provided little clear guidance on this topic. 

If the full value of the benefits were taxed the additional tax burden would be off the charts. 

What is a “Rich Plan”?

But there is another cautionary note in this example.  Policy makers hedge the discussion on taxing employee benefits by arguing that they may only tax “rich plans.”  But how do you define “rich plan”?  Will they take into account regional differences in health care costs?  Cities like Philadelphia and Boston are very high health care cost cities.  So how do you tax the employee benefits of employees of a Philadelphia employer.  Does the employer pay the same rate for its employees in Philadelphia as it does for its employees in Scranton or the employees in Danville?  Maybe, maybe not?  If the rate is the same for all employees, is it fair to tax the Danville employees who are subsidizing the  Philadelphia employees?  How will these cities market themselves with this additional tax burden to clear?

Most large employers are either experienced rated or self insured.  That means that the costs they pay reflect the actual medical claims incurred by the group.  So an employer who has an older population will generally pay more than an employer with younger employees.  Is it fair to tax employees simply because they work with an older work force?

Our plan provides benefits to retirees.  The rate for active employees subsidizes the costs for retirees.  This is the only way it can work when Taft-Hartley plans provide benefits to retirees.  Is it fair to tax an employee for benefits that are being received by someone else?

I have commented on this topic before, and I have also criticized federal policy makers for their preference for the complex over the simple.

Here is a policy that is simple and comprehensive.  Tinkering with it raises all sort of issues that accomplish very little other than tax those little able to afford it.  It will alienate the base of the Democratic Party who will be the source of that revenue.  Don’t change it!

Unless! Unless there will be a policy similar to one suggested in a proposal by Senator Ron Wyden. Pay to employees the money that employers now pay for health care.  Allow that income to be taxed.  And let the government provide the health care.


One Response to Tax My Benefits? The Devil in the Details

  1. jimmy1920 says:

    Do I dare flatter myself that this simple blog post has shifted the discussion away from the idea of taxing benefits? Nevertheless, Monday’s Washington Post had an AP story:
    What to tax to pay for health care?
    The article questioned if Congress had the stomach to tax benefits. I like to think it had more to do with brains than stomach, but such is Congress.

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