Eliminating the Tax Penalty on Gay-Friendly Businesses

September 12th, 2011

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Our corporate tax code dates back to 1986, before the internet and when China was “red.” It is hopelessly out of date with the goings on of the rest of the world, but there is one area where it is completely antiquated with changes in America: dealing with employee benefits for gay couples.

There are nearly one million gay couples living in the United States, according to the Census Bureau. Today, jurisdictions allowing gay couples to either marry or form legal unions are now home to about 150 million people—up from less than 15 million people fifteen years ago. And two-thirds of Fortune 1000 companies provide benefits like health care to gay couples. But if companies provide these benefits under the same tax formulation as they would for straight married couples, they are in violation of the law—and so are their employees.

Here’s the problem. While employer-provided health care is treated as a tax-free benefit for everyone else, the IRS counts it as taxable income for gay domestic partners and spouses. That means businesses like Target, IBM, and Nabisco who provide coverage to partners of their gay employees must go back and add “imputed income” to their employees’ pay stubs for the cost of that benefit.

This anomaly is both expensive and burdensome for business. First, since these non-wage benefits must be counted as wages, employers must kick in for FICA to the tune of at least $57 million a year in extra payroll taxes, according to the Williams Institute. Second, employers must keep a separate set of books for their gay employees to show they are correctly calculating the additional amount of taxable “income” they receive for their benefits. To add to the confusion, the IRS has refused to issue guidance on how to calculate the fair market value of a domestic partner’s health care coverage, so employers are in the dark over how to estimate the amount of imputed income.

For gay employees, the average cost is about $1,700 in additional taxes each year because what is considered tax-free for everyone else is considered income when those benefits apply to a gay partner. If this doesn’t seem just, it’s because it isn’t.

There is an easy fix. A small tweak in the tax code could put all employees on a level playing field by treating gay domestic partners and spouses like all other family members. There is already a bipartisan bill, the Tax Parity for Health Plan Beneficiaries Act, which has been introduced in both the House and Senate that would accomplish this task. The legislation would simply update tax law to reflect changing business practices and clarify that employer-provided health care is considered a benefit—not income—for all family members that an employer chooses to cover.

This commonsense adjustment would do away with the confusing and unwieldy exception in current law, and it would eliminate pointless bureaucracy and unintended costs to businesses. As Washington continues to look for ways to streamline regulations and taxes on employers to spur growth, this straightforward change is one that policymakers should jump at the chance to enact.

As Congress returns to Washington this fall, the talk of the town is all about the super committee, tax reform, and reducing burdens on business to help get the economy moving. The Obama Administration just identified more than 500 recommended cuts to regulations that would help save the government and businesses money and reduce impediments to job creation. Unfortunately, this particular change needs to come through Congress, and the Republican-controlled House of Representatives won’t pass a stand-alone bill that is seen as pro-gay. But the fix could be included in a larger piece of legislation like tax reform—in fact, it was originally included in the health care reform bill, but it got lost along the way in the endless negotiations and fell out of the final version.

Policymakers on both sides of the aisle are pushing for reforms to streamline the tax code in ways that would make it more efficient for business and encourage economic growth. This is a bipartisan idea that pleases both business and progressives. What could be better?