BILL ANALYSIS                                                                                                                                                                                                    




                                                                  AB 362
                                                                  Page A
          Date of Hearing:  May 13, 2013

                     ASSEMBLY COMMITTEE ON REVENUE AND TAXATION
                                Raul Bocanegra, Chair

                      AB 362 (Ting) - As Amended:  April 2, 2013

                                      SUSPENSE

          Majority vote.  Tax levy.  Fiscal committee.
           
          SUBJECT  :  Personal income taxes:  exclusion:  health insurance

           SUMMARY  :   Excludes from state gross income reimbursement  
          received from an employer for federal income taxes paid by the  
          employee because federal income tax law does not consider the  
          employee's same-sex spouse or domestic partner to be the  
          employee's spouse, including any reimbursement of federal income  
          taxes paid with respect to those amounts.  Specifically,  this  
          bill  :  

          1)Excludes from state gross income reimbursement received from  
            an employer for federal income taxes paid by the employee  
            because federal income tax law does not consider the  
            employee's same-sex spouse or domestic partner to be the  
            employee's spouse for purposes of the federal exclusion of  
            employer-provided health coverage.
                                    
          2)Excludes from state gross income amounts received from an  
            employer to reimburse the employee for additional federal  
            income taxes paid as a result of the reimbursement itself.
                                  
          3)Takes immediate effect as a tax levy.
                                                       
           EXISTING FEDERAL LAW  :

          1)Excludes from federal gross income health insurance provided  
            by an employer to an employee, an employee's dependents, and  
            an employee's opposite-sex spouse.  Generally, the smaller a  
            taxpayer's federal gross income, the lower that taxpayer's  
            federal tax liability will be.


          2)Includes in an employee's federal gross income health  
            insurance provided by an employer to a domestic partner, a  









                                                                  AB 362
                                                                  Page B
            same-sex spouse, or the domestic partner's or same-sex  
            spouse's dependents.  Generally, the greater a taxpayer's  
            federal gross income, the greater that taxpayer's federal tax  
            liability will be.


          3)Includes in federal gross income any amount paid by another on  
            behalf of a taxpayer to discharge a liability of the taxpayer,  
            including a tax liability.  Generally, the greater a  
            taxpayer's federal gross income, the greater that taxpayer's  
            federal tax liability will be.


          4)Allows a taxpayer to claim a personal exemption for each of  
            the taxpayer's dependents.  Generally, the more dependents a  
            taxpayer may claim, the lower that taxpayer's federal tax  
            liability will be.


          5)Does not classify the children of a taxpayer's domestic  
            partner or same-sex spouse as dependents of the taxpayer,  
            generally.  Generally, the fewer dependents a taxpayer may  
            claim, the greater that taxpayer's federal tax liability will  
            be.


           EXISTING STATE LAW  :


          1)Excludes from state gross income health insurance provided by  
            an employer to an employee, an employee's dependents, an  
            employee's spouse, or an employee's domestic partner,  
            regardless of whether the employee's spouse or domestic  
            partner is the same or opposite sex of the employee.   
            Generally, the smaller a taxpayer's state gross income, the  
            lower that taxpayer's state tax liability will be.


          2)Includes in state gross income any amount paid by another on  
            behalf of a taxpayer to discharge a liability of the taxpayer,  
            including a tax liability.  Generally, the greater a  
            taxpayer's state gross income, the greater that taxpayer's  
            state tax liability will be.











                                                                  AB 362
                                                                  Page C
          3)Classifies the children of a taxpayer's domestic partner or  
            same-sex spouse as dependents of the taxpayer, subject to  
            certain requirements.  Generally, the more dependents a  
            taxpayer may claim, the lower that taxpayer's state tax  
            liability will be.


           FISCAL EFFECT  :   The Franchise Tax Board (FTB) has provided the  
          following revenue estimate:


             --------------------------------------------------------------- 
            |                                                               |
            |    For Taxable Years Beginning On or After January 1, 2013    |
            |                                                               |
            |             Assumed Enactment After June 30, 2013             |
            |                                                               |
            |                                                               |
            |                        ($ in Millions)                        |
            |                                                               |
             --------------------------------------------------------------- 
            |-------------+----------------+----------------+----------------|
            |Fiscal Year  |    2013-14     |    2014-15     |    2015-16     |
            |-------------+----------------+----------------+----------------|
            |Amount       |     - $1.8     |     - $1.2     |-               |
            |             |                |                |$1.3            |
             ---------------------------------------------------------------- 

           COMMENTS  :   

          1)The author has provided the following statement in support of  
            this bill:

               At the heart of this issue is a question of fairness for  
               same-sex couples.  The federal policy to tax the health  
               care benefits of same-sex couples and same-sex headed  
               families is discriminatory, and the last thing the state of  
               California should do is make it harder to remedy the  
               injustice by taxing the reimbursement of these costs.  This  
               legislation will expand on, and strengthen, California's  
               rich history of non-discrimination.

          2)Proponents state:

               Unfortunately, because the federal Defense of Marriage Act  









                                                                  AB 362
                                                                  Page D
               (DOMA) prohibits recognition of same-sex partnerships, the  
               government treats health insurance benefits provided  
               through a same-sex spouse's or domestic partner's employer  
               as income and taxes them.  The federal government does not  
               tax these benefits as income for different-sex couples.   
               When a California employer provides reimbursement to its  
               employees for this federal tax, often referred to as a  
               "gross-up," California taxes this reimbursement as  
               additional income.

          3)Committee Staff Comments:


                a)     An Illustration of How the Bill Works  :  The  
                 following discussion illustrates how this bill works  
                 using several hypotheticals and examples.


                 Many employers pay for health insurance for their  
                 employees and their employees' loved ones.  Under federal  
                 and California income tax law, an employee does not pay  
                 taxes for health insurance the employer provides to the  
                 employee's opposite-sex spouse.  California and federal  
                 income taxes exclude the opposite-sex spouse's health  
                 insurance from the employee's gross income.  This results  
                 in an employee receiving health insurance for the  
                 employee's opposite-sex spouse tax free.


                 The same is true of same-sex domestic partners and  
                 spouses under California tax law.  An employee does not  
                 pay California income taxes for health insurance the  
                 employer provides to the employee's same-sex domestic  
                 partner or spouse.  California income taxes exclude the  
                 same-sex spouse's health insurance from the employee's  
                 gross income.  Thus, an employee may receive health  
                 insurance for the employee's same-sex spouse without  
                 paying California income taxes.


                 However, the same cannot be said of federal tax law.   
                 Federal income tax law includes health insurance an  
                 employer provides to an employee's same-sex domestic  
                 partner or spouse in the employee's gross income.  While  
                 an employee may receive health insurance for the  









                                                                  AB 362
                                                                  Page E
                 employee's opposite-sex spouse without paying federal  
                 taxes, an employee must pay federal income taxes for  
                 health insurance for the employee's same-sex domestic  
                 partner or spouse.


                 Some examples will best illustrate the disparate income  
                 tax treatment of health coverage for opposite-sex and  
                 same-sex couples.


                 Assume an employee is in the 35% federal income tax  
                 bracket and in the 12.3% California income tax bracket in  
                 the 2012 taxable year.  The employee has an opposite-sex  
                 spouse.  The employer pays for the employee's spouse's  
                 health insurance coverage.  The value of the employee's  
                 spouse's coverage is $5,000 per year.  Although the  
                 employee receives something of value from the employer -  
                 health insurance worth $5,000 for the employee's spouse -  
                 the employee does not pay any income tax on that amount.


                 Now imagine a situation identical to the hypothetical  
                 discussed above with one modification.  The employee has  
                 a same-sex domestic partner.  The employer pays for the  
                 employee's partner's health insurance coverage.  As  
                 before, the value of the employee's partner's coverage is  
                 $5,000 per year.  The employee is in the 35% federal tax  
                 bracket and in the 12.3% state tax bracket.  The employee  
                 must pay $5,000 * 35% = $1,750 in federal taxes for the  
                 employee's domestic partner's health insurance coverage  
                 each year.  The employee does not have to pay California  
                 taxes for the health insurance coverage.  The employee  
                 has $1,750 less after-tax income than the employee would  
                 if the employee were a member of an opposite-sex  
                 marriage.<1>


                 ------------------------
          <1> Note that these examples do not consider other taxes, such  
          as Social Security (FICA), Medicare, Federal Unemployment Tax  
          (FUTA), California State Disability Insurance, California State  
          Unemployment Insurance, California State Employment Training  
          Tax, local taxes, and others.










                                                                  AB 362
                                                                  Page F
                 Some employers attempt to offset the burden that federal  
                 tax law imposes upon employees who are members of  
                 same-sex couples.  These employers pay the additional tax  
                 an employee must pay for the employee's same-sex domestic  
                 partner's or spouse's health insurance.  In other words,  
                 they "gross up" the employee's salary.  The goal is to  
                 ensure that an employee who is in a same-sex domestic  
                 partnership or marriage receives the same after-tax  
                 income as the employee would if the employee were in an  
                 opposite-sex marriage.


                 An example will help illustrate how grossing up works.


                 Once again, assume an employee is in the 35% federal tax  
                 bracket and in the 12.3% California tax bracket.<2>  The  
                 employee has a same-sex partner.  The employer pays for  
                 the employee's partner's health insurance coverage.  The  
                 value of the employee's partner's coverage is $5,000 per  
                 year.  The employee must pay $5,000 * 35% = $1,750 in  
                 federal taxes for the employee's domestic partner's  
                 health insurance coverage each year.  The employee does  
                 not have to pay California taxes for the health insurance  
                 coverage.


                 The employer decides to "gross up" the employee's salary  
                 so that the employee has the same after-tax income as the  
                 employee would if the employee were in an opposite-sex  
                 marriage.  To offset the $1,750 in federal income taxes  
                 the employee must pay for the employee's partner's  
                 coverage, the employer pays the federal government $1,750  
                 on the employee's behalf.


                 This is where things get complicated.  The employer is  
                 paying $1,750 of the employee's taxes for the employee.   
                 ------------------------


          <2> Please note this hypothetical uses these marginal tax rates  
          because they are the current top marginal tax rates under  
          federal and California law, respectively.  Their use greatly  
          simplifies the following calculations.  They are not meant to  
          reflect the tax rates of typical couples.








                                                                  AB 362
                                                                  Page G
                 Federal and state tax law characterizes such a payment as  
                 $1,750 additional income to the employee.  Ironically,  
                 paying the employee's taxes increases the employee's  
                 taxes.  Specifically, the employee now owes $1,750 *  
                 12.3% = $215.25 more in California taxes and ($1,750 -  
                 $215.25 state tax deduction) * 35% = $537.16 more in  
                 federal taxes.


                 Note that the increase in the employee's California and  
                 federal taxes, $215.25 + $537.16 = $752.41, is less than  
                 the amount the employer paid on the employee's behalf,  
                 $1,750.  The employee is still better off after-tax than  
                 the employee was before, to the extent of the difference  
                 between $1,750 and $752.41, which is $997.59.


                 Nonetheless, the employee's after-tax income is still  
                 less than that of the employee's straight peers.  Namely,  
                 it is $752.41 less.  The employer acknowledges this is  
                 still unfair discrimination.  It decides to "gross up"  
                 the employee's salary once more.  And so, things get yet  
                 more complicated.


                 To offset the new increase in taxes resulting from the  
                 additional payment of $752.41, the employer would have to  
                 pay California $752.41 * 12.3% = $92.55and the federal  
                 government ($752.41 - $92.55) * 35% = $230.95.  Once  
                 more, the employer is paying the employee's taxes for the  
                 employee.  This increases the employee's gross income  
                 $92.55 + $230.95 = $323.50.  The employee must once again  
                 pay tax on the $323.50 the employer pays on the  
                 employee's behalf.


                 This spirals, depending upon how many times the employer  
                 chooses to increase the employee's salary.  The employer  
                 pays taxes on the employee's behalf and then pays more to  
                 offset the employee's increased tax liability resulting  
                 from the preceding "gross up."  Each time, the amount of  
                 additional tax the employee must pay shrinks.   
                 Eventually, the additional tax is less than a cent and  
                 the spiral ends.










                                                                  AB 362
                                                                  Page H

                 The chart below shows how this spiral works.


          
           ------------------------------------------------------------------ 
          |                             Chart 1                              |
           ------------------------------------------------------------------ 
           -------------------------------------------------------------------------------------------------------- 
          |                    |Additional Income   |California Income   |Federal Income      |California &        |
          |                    |                    |Taxes               |Taxes               |Federal Income      |
          |                    |                    |                    |                    |Taxes               |
           -------------------------------------------------------------------------------------------------------- 
          |---------+--------+-------------+-----------------+--------------|
          |Value of |$5,000.0|$0.00 *      |($5,000.00 -     |$0.00 +       |
          |the      |0       |12.3%        |$0.00)           |$1,750.00     |
          |Health   |        |= $0.00      |* 35% =          |= $1,750.00   |
          |Insurance|        |             |$1,750.00        |              |
          |         |        |             |                 |              |
          |---------+--------+-------------+-----------------+--------------|
          |1        |$1,750.0|$1,750.00 *  |($1,750.00 -     |$215.25 +     |
          |         |0       |12.3% =      |$215.25)         |$537.16       |
          |         |        |$215.25      |* 35% = $537.16  |= $752.41     |
          |---------+--------+-------------+-----------------+--------------|
          |2        |$752.41 |$752.41 *    |($752.41 -       |$92.55 +      |
          |         |        |12.3%        |$92.55)          |$230.95       |
          |         |        |= $92.55     |* 35% = $230.95  |= $323.50     |
          |---------+--------+-------------+-----------------+--------------|
          |3        |$323.50 |$323.50 *    |($323.50 -       |$39.79 +      |
          |         |        |12.3%        |$39.79)          |$99.30        |
          |         |        |= $39.79     |* 35% = $99.30   |= $139.09     |
          |---------+--------+-------------+-----------------+--------------|
          |4        |$139.09 |$139.09 *    |($139.09 -       |$17.11 +      |
          |         |        |12.3%        |$17.11)          |$42.69        |
          |         |        |= $17.11     |* 35% = $42.69   |= $59.80      |
          |---------+--------+-------------+-----------------+--------------|
          |5        |$59.80  |$59.80 *     |($59.80 - $7.36) |$7.36 +       |
          |         |        |12.3%        |* 35%            |$18.36        |
          |         |        |= $7.36      |= $18.36         |= $25.71      |
          |---------+--------+-------------+-----------------+--------------|
          |6        |$25.71  |$25.71 *     |($25.71 - $3.16) |$3.16 + $7.89 |
          |         |        |12.3%        |* 35%            |= $11.05      |
          |         |        |= $3.16      |= $7.89          |              |
          |---------+--------+-------------+-----------------+--------------|
          |7        |$11.05  |$11.05 *     |($11.05 - $1.36) |$1.36 + $3.39 |









                                                                  AB 362
                                                                  Page I
          |         |        |12.3%        |* 35%            |= $4.75       |
          |         |        |= $1.36      |= $3.39          |              |
          |---------+--------+-------------+-----------------+--------------|
          |8        |$4.75   |$4.75 *      |($4.75 - $0.58)  |$0.58 + $1.46 |
          |         |        |12.3%        |* 35%            |= $2.04       |
          |         |        |= $0.58      |= $1.46          |              |
          |---------+--------+-------------+-----------------+--------------|
          |9        |$2.04   |$2.04 *      |($2.04 - $0.25)  |$0.25 + $0.63 |
          |         |        |12.3%        |* 35%            |= $0.88       |
          |         |        |= $0.25      |= $0.63          |              |
          |---------+--------+-------------+-----------------+--------------|
          |10       |$0.88   |$0.88 *      |($0.88 - $0.11)  |$0.11 + $0.27 |
          |         |        |12.3%        |* 35%            |= $0.38       |
          |         |        |= $0.11      |= $0.27          |              |
          |---------+--------+-------------+-----------------+--------------|
          |11       |$0.38   |$0.38 *      |($0.38 - $0.05)  |$0.05 + $0.12 |
          |         |        |12.3%        |* 35%            |= $0.16       |
          |         |        |= $0.05      |= $0.12          |              |
          |---------+--------+-------------+-----------------+--------------|
          |12       |$0.16   |$0.16 *      |($0.16 - $0.02)  |$0.02 + $0.05 |
          |         |        |12.3%        |* 35%            |= $0.07       |
          |         |        |= $0.02      |= $0.05          |              |
          |---------+--------+-------------+-----------------+--------------|
          |13       |$0.07   |$0.07 *      |($0.07 - $0.01)  |$0.01 + $0.02 |
          |         |        |12.3%        |* 35%            |= $0.03       |
          |         |        |= $0.01      |= $0.02          |              |
           ----------------------------------------------------------------- 
          |14       |$0.03   |$0.03 *      |($0.03 - $0.00)  |$0.00 + $0.01 |
          |         |        |12.3%        |* 35%            |= $0.01       |
          |         |        |= $0.00      |= $0.01          |              |
          |---------+--------+-------------+-----------------+--------------|
          |15       |$0.01   |$0.01 *      |($0.01 - $0.00)  |$0.00 + $0.00 |
          |         |        |12.3%        |* 35%            |= $0.00       |
          |         |        |= $0.00      |= $0.00          |              |
           ----------------------------------------------------------------- 
           -------------------------------------------------------------------------------------------------------- 
          |Totals              |                    |$377.60             | $2,692.31          |$3,069.90           |
           -------------------------------------------------------------------------------------------------------- 
                 


                 To give an employee the same after-tax income as the  
                 employee would have if the employee were in an  
                 opposite-sex marriage, the employer would have to pay  
                 $377.60 more in state taxes and $2,692.31 more in federal  









                                                                  AB 362
                                                                  Page J
                 taxes on the employee's behalf.  The total increase in  
                 tax is $3,069.90, as is the "gross up."  This means that  
                 to provide an employee the same after-tax treatment, the  
                 combined federal and state effective tax rate on medical  
                 insurance is $3,069.90 / $5,000 = 61.40%.
                 The employer may deduct the entire cost of the "gross up"  
                 as a business expense, thereby reducing the employer's  
                 gross income $3,069.90.


                 This bill would make Chart 1 look like the chart below.   
                 The cells shaded gray indicate the main difference  
                 between Chart 1 and the chart below.


          
           ------------------------------------------------------------------ 
          |                             Chart 2                              |
           ------------------------------------------------------------------ 
           -------------------------------------------------------------------------------------------------------- 
          |                    |Additional Income   |California Income   |Federal Income      |California &        |
          |                    |                    |Taxes               |Taxes               |Federal Income      |
          |                    |                    |                    |                    |Taxes               |
           -------------------------------------------------------------------------------------------------------- 
          |---------+--------+------------+------------------+--------------|
          |Value of |$5,000.0|$0.00 *     |($5,000.00 -      |$0.00 +       |
          |the      |0       |12.3%       |$0.00) * 35%      |$1,750.00     |
                                                             |Health   |        |= $0.00     |= $1,750.00       |= $1,750.00   |
          |Insurance|        |            |                  |              |
          |         |        |            |                  |              |
          |---------+--------+------------+------------------+--------------|
          |1        |$1,750.0|$0.00 *     |($1,750.00 -      |$0.00 +       |
          |         |0       |12.3%       |$0.00) * 35%      |$612.50       |
          |         |        |= $0.00     |= $612.50         |= $612.50     |
          |---------+--------+------------+------------------+--------------|
          |2        |$612.50 |$0.00 *     |($612.50 - $0.00) |$0.00 +       |
          |         |        |12.3%       |* 35%             |$214.38       |
          |         |        |= $0.00     |= $214.38         |= $214.38     |
          |---------+--------+------------+------------------+--------------|
          |3        |$214.38 |$214.38 *   |($214.38 -        |$26.37 +      |
          |         |        |12.3%       |$26.37) * 35%     |$65.80        |
          |         |        |= $26.37    |= $65.80          |= $92.17      |
          |---------+--------+------------+------------------+--------------|
          |4        |$92.17  |$92.17 *    |($92.17 - $11.34) |$11.34 +      |
          |         |        |12.3%       |* 35%             |$28.29        |









                                                                  AB 362
                                                                  Page K
          |         |        |= $11.34    |= $28.29          |= $39.63      |
          |---------+--------+------------+------------------+--------------|
          |5        |$39.63  |$39.63 *    |($39.63 - $4.87)  |$4.87 +       |
          |         |        |12.3%       |* 35%             |$12.16        |
          |         |        |= $4.87     |= $12.16          |= $17.04      |
          |---------+--------+------------+------------------+--------------|
          |6        |$17.04  |$17.04 *    |($17.04 - $2.10)  |$2.10 + $5.23 |
          |         |        |12.3%       |* 35%             |= $7.33       |
          |         |        |= $2.10     |= $5.23           |              |
          |---------+--------+------------+------------------+--------------|
          |7        |$7.33   |$7.33 *     |($7.33 - $0.90) * |$0.90 + $2.25 |
          |         |        |12.3%       |35%               |= $3.15       |
          |         |        |= $0.90     |= $2.25           |              |
          |---------+--------+------------+------------------+--------------|
          |8        |$3.15   |$3.15 *     |($3.15 - $0.39) * |$0.39 + $0.97 |
          |         |        |12.3%       |35%               |= $1.35       |
          |         |        |= $0.39     |= $0.97           |              |
          |---------+--------+------------+------------------+--------------|
          |9        |$1.35   |$1.35 *     |($1.35 - $0.17) * |$0.17 + $0.42 |
          |         |        |12.3%       |35%               |= $0.58       |
          |         |        |= $0.17     |= $0.42           |              |
          |---------+--------+------------+------------------+--------------|
          |10       |$0.58   |$0.58 *     |($0.58 - $0.07) * |$0.07 + $0.18 |
          |         |        |12.3%       |35%               |= $0.25       |
          |         |        |= $0.07     |= $0.18           |              |
          |---------+--------+------------+------------------+--------------|
          |11       |$0.25   |$0.25 *     |($0.25 - $0.03) * |$0.03 + $0.08 |
          |         |        |12.3%       |35%               |= $0.11       |
          |         |        |= $0.03     |= $0.08           |              |
          |---------+--------+------------+------------------+--------------|
          |12       |$0.11   |$0.11 *     |($0.11 - $0.01) * |$0.01 + $0.03 |
          |         |        |12.3%       |35%               |= $0.05       |
          |         |        |= $0.01     |= $0.03           |              |
          |---------+--------+------------+------------------+--------------|
          |13       |$0.05   |$0.05 *     |($0.05 - $0.01) * |$0.01 + $0.01 |
          |         |        |12.3%       |35%               |= $0.02       |
          |         |        |= $0.01     |= $0.01           |              |
           ----------------------------------------------------------------- 
          |14       |$0.02   |$0.02 *     |($0.02 - $0.00) * |$0.00 + $0.01 |
          |         |        |12.3%       |35%               |= $0.01       |
          |         |        |= $0.00     |= $0.01           |              |
          |---------+--------+------------+------------------+--------------|
          |15       |$0.01   |$0.01 *     |($0.01 - $0.00) * |$0.00 + $0.00 |
          |         |        |12.3%       |35%               |= $0.00       |
          |         |        |= $0.00     |= $0.00           |              |









                                                                  AB 362
                                                                  Page L
           ----------------------------------------------------------------- 
           -------------------------------------------------------------------------------------------------------- 
          |Totals              |                    |$46.26              |$2,692.31           |$2,738.56           |
          |                    |                    |                    |                    |                    |
           -------------------------------------------------------------------------------------------------------- 
          
                 Under this bill, to provide an employee the same  
                 after-tax income as the employee would have if the  
                 employee were in an opposite-sex marriage, the employer  
                 would pay only $46.26 in California income taxes and  
                 $2,692.31 in federal taxes on the employee's behalf.  The  
                 total increase in tax would be $2,738.56, as would the  
                 "gross up."  This means that to provide an employee the  
                 same after-tax consequences the employee would have if  
                 the employee were in an opposite-sex marriage, the  
                 combined federal and state tax rate on medical insurance  
                 would be $2,738.56 / $5,000 = 54.77%.


                 This bill would therefore make it less expensive to fully  
                 "gross up" an employee's wages.  Rather than costing the  
                 employer $3,069.90, the employer would pay $2,738.56, a  
                 $331.34 difference.


                 The bill would also result in a decrease in revenues to  
                 California because it taxes the "grossed-up" employee  
                 less.  Namely, $377.60 - $46.26 = $331.34 less.


                a)     A Paradox - This Bill is Both Cutting Edge and  
                 Potentially Moot  :  As far as Committee staff is aware, no  
                 state has ever crafted an income exclusion based upon a  
                 taxpayer's federal tax liability.  Were this bill to  
                 enter into law, it would be a novel and historic  
                 development in tax law.


                 However, even though this bill breaks new ground, this  
                 bill is still potentially moot, depending upon the  
                 actions of the United States Supreme Court.


                 The United States Supreme Court recently heard oral  
                 arguments in United States v. Windsor and Hollingsworth  









                                                                  AB 362
                                                                  Page M
                 v. Perry.  United States v. Windsor concerns the  
                 constitutionality of the Defense of Marriage Act.  If the  
                 United States Supreme Court finds provisions of the  
                 Defense of Marriage Act unconstitutional, the federal  
                 government would potentially have to extend all the  
                 federal benefits of opposite-sex marriages to same-sex  
                 marriages in those states in which same-sex marriages are  
                 allowed.  Moreover, if the United States Supreme Court  
                 does not reverse the 9th Circuit's ruling or the District  
                 Court's ruling in Hollingsworth v. Perry, California  
                 would once more allow same-sex marriages.


                 If both of these cases reached these outcomes, this bill  
                 would affect little change in the law.  An employee in a  
                 same-sex marriage would no longer incur increased federal  
                 income taxes.  There would be nothing to offset.


                 There is only one change proposed by this bill that would  
                 survive such rulings by the United States Supreme Court.   
                 It concerns domestic partners.  No matter the United  
                 States Supreme Court's actions, the federal government  
                 would likely still not accord beneficial tax treatment to  
                 either opposite-sex or same-sex domestic partnerships.   
                 An employer could still choose to "gross up" an  
                 employee's wages to offset the increased federal income  
                 tax liability of the employee.  This bill would continue  
                 to exclude such offsets from the employee's California  
                 gross income, provided the domestic partner was a  
                 same-sex domestic partner.  Opposite-sex domestic  
                 partners would continue to pay increased federal income  
                 taxes, under this scenario.


                 In such a situation, same-sex domestic partners could  
                 marry and avoid increased federal income taxes in the  
                 first place.  Although some couples might not wish to  
                 marry for any number of reasons, it is unclear California  
                 should forego state tax revenue when such couples could  
                 reduce their federal tax liabilities on their own and  
                 choose not to.  Encouraging tax neutrality between  
                 marriage and domestic partnerships would be the only  
                 justification to continue to provide an exclusion even  
                 when taxpayers do not need one.  If such tax neutrality  









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                 between marriage and domestic partnerships is the goal  
                 however, it is not clear why this bill does not provide  
                 an exclusion for opposite-sex domestic partners as  
                 well.<3>


                b)     A Past Tense Problem  : This bill uses the words  
                 "paid" and "reimburse."  Such terminology implies the  
                 taxpayer "paid" the extra taxes owed and then received a  
                 check as "reimbursement."  Most employers who "gross up"  
                 their employees' salaries do so during the same taxable  
                 year that the employees' spouses or partners receive  
                 their health insurance.  They pay the taxes on behalf of  
                 the employee directly to the federal government in the  
                 taxable year itself.  Employers do not reimburse the  
                 taxpayer after the taxpayer has paid and filed his or her  
                 taxes - often, in April of the following taxable year.


                 Employers follow this practice for several reasons.   
                 First, it prevents employees from facing liquidity  
                 problems.  Second, tax rates may change from one taxable  
                 year to the next.  If the employer instead reimbursed the  
                 additional taxes the employee paid, the reimbursement  
                 itself would increase an employee's gross income in a  
                 different taxable year than the year in which the  
                 employer provided health insurance.  If tax rates rose in  
                 the later year, the employer would need to re-calculate  
                 how much to reimburse an employee for the taxes incurred  
                 on the reimbursement itself.  As the above calculations  
                 show, performing a single calculation is already a  
                 nightmare.  Two would be unbearable.  Third, it takes an  
                 inordinate amount of time.  If an employer reimbursed an  
                 employee for the taxes from the first "gross up," it  
                 would need to do so in the taxable year following the  
                 reimbursement - two years after the employer provided  
                 health insurance.
                 ------------------------


          <3> Committee staff question whether employers would continue to  
          "gross up" a California employee's wages when the employee could  
          instead marry their same-sex domestic partner and avoid  
          increased federal income taxes in the first place.   
          Additionally, Committee staff are unaware of employers that  
          currently "gross up" wages for opposite-sex domestic partners.








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                 This bill's authors may wish to amend this bill  
                 accordingly.


                c)     Why Not Exclude the Entire Spiral?  :  As shown above  
                 in Chart 2, this bill's exclusion only goes so far.  It  
                 excludes the first "gross up."<4>  It also excludes any  
                 amount the employer pays the employee to compensate for  
                 the federal income taxes owed on the first "gross up"  
                 amount itself.  But this is where the exclusion's  
                 generosity ends.  In other words, the bill does not  
                 exclude amounts paid to compensate an employee for the  
                 increased federal tax liability resulting from the  
                 "second gross up."


                d)     What about Step-Children?  :  Federal gross income  
                 does not include the value of health insurance an  
                 employer provides to an employee's opposite-sex spouse's  
                 children, subject to certain requirements.  26 U.S.C.   
                 152(f)(1)(A)(i), Treasury Regulations Section 1.106-1.


                 Given this bill's purpose, the author may wish to make  
                 explicit that state gross income shall not include  
                 amounts paid to "gross up" an employee's salary to offset  
                 increased federal income taxes an employee incurs because  
                 the same-sex spouse's or domestic partner's children are  
                 not treated as the employee's stepchildren for federal  
                 income tax purposes.


                e)     Suggested Amendments  :  Committee staff suggest  
                 amending this bill to:


                  i)        Rework the bill's language to eliminate the  
                    bill's past tense problem.
                  -----------------------


          <4> The amount the employer pays to offset federal income taxes  
          the employee pays because the employer provides health insurance  
          coverage to the employee's domestic partner or same-sex spouse.








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                  ii)       Include a sunset provision.  Such a sunset  
                    provision could be for a term of years.   
                    Alternatively, a sunset provision could trigger this  
                    act's repeal once the same-sex spouse or domestic  
                    partner of a California employee is considered the  
                    spouse of the employee under Section 105 or Section  
                    106 of the Internal Revenue Code, as determined by a  
                    federal appeals court of competent jurisdiction or  
                    through an act of the United States Congress.  If no  
                    sunset provision is included, this bill's repeal would  
                    require a 2/3 majority from a future legislature.


           REGISTERED SUPPORT / OPPOSITION  :   

           Support 
           
          Equality California (sponsor)
          AIDS Project Los Angeles
          Alice B. Toklas LGBT Democratic Club
          American Federation of State, County, and Municipal Employees
          California Nurses Association
          California Immigrant Policy Center
          Facebook
          Harvey Milk LGBT Democratic Club
          Health Access California
          Los Angeles Gay & Lesbian Center
          Microsoft
          San Francisco Chamber of Commerce
          San Francisco Mayor Edwin M. Lee




           Opposition 
           
          None on file
           
          Analysis Prepared by  :   Edward Beeby and M. David Ruff / REV. &  
          TAX. / (916) 319-2098 












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