chevron-down Created with Sketch Beta.
May 10, 2013 Articles

Tax Gross-Up as an Equalizer for Employees

By Erin E. Bohacek

The issue of same-sex marriage has received an enormous amount of attention recently, not only from the media and the various talking heads espousing both positive and negative commentary but also from state legislatures, the president, and even the U.S. Supreme Court. An individual's marital status is generally determined under state law for purposes of administering federal tax law. Windsor v. United States, 699 F.3d 169, 177 (2d Cir. 2012). However, section 3 of the Defense of Marriage Act (DOMA) provides that in interpreting the meaning of federal law, the word "spouse" "refers only to a person of the opposite sex who is a husband or wife." DOMA currently prevents same-sex couples from taking advantage of the tax benefits that their straight counterparts receive, including the exclusion from income of employer-paid health benefits to an employee's spouse. There has been a growing trend lately whereby an employer will not only pay for the health benefits of its same-sex employees' spouses and domestic partners but also offer a "tax gross-up"—reimbursement for the tax incurred by a same-sex employee as a result of the health benefits paid to that employee's spouse or domestic partner.

Legal Basis for Tax Disparity
An associate at a mid-size law firm who receives a salary of, say, $110,000 is usually quick to forget that his or her compensation is actually much higher as a result of various employer-provided fringe benefits, including health insurance and the option to add spouses and dependents. There are two reasons for this. First, employer-provided health insurance is not money in hand. Second, thanks to section 106 of the Internal Revenue Code and Treasury regulations, employer-paid health insurance is not taxable income to the employee or to his or her spouse or dependents. See Treas. Reg. § 1.106-1 ("The gross income of an employee does not include contributions which his employer makes to an accident or health plan for compensation (through insurance or otherwise) to the employee for personal injuries or sickness incurred by him, his spouse, or his dependents, as defined by Section 152."). Of course, if you're gay, a different rule applies. Because the federal tax laws must be interpreted with section 3 of DOMA in mind, section 106 of the Internal Revenue Code does not exclude from income health benefits paid by an employer for the benefit of an employee's same-sex spouse. See I.R.S. Priv. Ltr. Rul. 9717018 (Jan. 22, 1997). Instead, these health benefits are treated as taxable fringe benefits furnished to the employee and must be reported as income by the employee on his or her tax return. See I.R.C. § 61(a)(1); Treas. Reg. § 1.61-21(a)(1), (a)(4) & (b)(1).

Response by the Legal Community
In the past several years, there has been a push for employers not only to cover the cost of health insurance for same-sex spouses and domestic partners but also to offer a tax gross-up. With law firms vying to obtain the best, most talented young lawyers (some of whom are likely gay or support equality in the workplace), competition with other large firms may be a driving factor. According to a report prepared by the New York Times, which polled numerous global firms as well as leaders in other industries, the majority of law firms polled adopted their policies effective January 1, 2011 or retroactive to January 1, 2011. Tara Siegel Bernard, "A Progress Report on Gay Employee Health Benefits," N.Y. Times, Dec. 14, 2010 (chart updated Dec. 5, 2012).

After reading about the tax gross-up in the New York Times, Eric Klinger-Wilensky, a Delaware lawyer, pitched the tax gross-up policy to his firm, Morris Nichols Arsht & Tunnell, in the summer of 2012. Klinger-Wilensky, who is openly gay and was married in New York in 2008, sees the gross-up as an issue of fairness. The policy was approved by Morris Nichols in only two months and benefits the firm's same-sex attorneys and support staff who are taxed on the health benefits provided by the firm to their spouses or domestic partners. "To the extent that you are disadvantaged from a tax perspective as a result of the medical payments, you're covered," Klinger-Wilensky said. Calculating the gross-up was perhaps the most difficult challenge for Morris Nichols because the initial payment made to reimburse an employee for the tax paid is also subject to tax. The subsequent payment to cover the second tax is also taxed, and so on and so forth. In addition, any money paid to same-sex employees as part of the gross-up is money coming out of the pockets of the law firm's partners—money that would remain in their pockets if DOMA was not a factor.

Morris Nichols is not the only law firm—or employer, for that matter—to face the difficulties and expenses associated with implementing a tax gross-up. On February 26, 2013, 278 employers, including 41 law firms, filed an amicus brief with the U.S. Supreme Court in United States v. Windsor, a same-sex marriage case out of New York, where the estate of the respondent's wife was initially denied the estate tax marital deduction as a result of DOMA. Windsor, 699 F.3d at 175–76. Amici argued that "DOMA obliges employers to treat an employee married to someone of the same sex and an employee married to someone of a different sex unequally" in the "[t]welve states, the District of Columbia, and the three federally recognized Indian tribes [that] now either authorize the marriages of same-sex couples, or recognize (to varying degrees) such marriages when performed in other states." Brief of 278 Employers and Organizations Representing Employers as Amici Curiae in Support of Respondent Edith Schlain Windsor at 11–12, United States v. Windsor, No. 12-307 (2013).

Amici—including law firms that offer the tax gross-up, among them Baker & McKenzie LLP; Ropes & Gray, LLP; and Skadden, Arps, Slate, Meagher & Flom LLP—point to the complexities and costs thrust on employers as a result of DOMA as an argument against the law: "These policies impose a direct cost on the employer. They carry administrative burden, requiring amici to retain experts to craft the policies and structure systems that can record gross-up amounts, educate human resources, benefits, and payroll administrators and manage dual systems." Id. at 30 (The reference to dual systems refers to the two systems that must be administered for married employees with opposite-sex spouses and married employees with same-sex spouses.).

The tax gross-up offered by some employers to employees with same-sex spouses, even though equitable to employees, is certainly an expensive burden to employers as a result of DOMA. Nevertheless, many law firms have stepped up in an attempt to equal the playing field for same-sex employees by offering the tax gross-up as a benefit to their lawyers and support staff. The good news for these firms (and, more important, for the millions of gay people in this country) is that with a decision in Windsor fast approaching, we may see the downfall of DOMA and the necessity for the tax gross-up.

Keywords: litigation, LGBT, DOMA, Windsor v. United States, tax gross-up, federal benefits, health insurance

Copyright © 2018, American Bar Association. All rights reserved. This information or any portion thereof may not be copied or disseminated in any form or by any means or downloaded or stored in an electronic database or retrieval system without the express written consent of the American Bar Association. The views expressed in this article are those of the author(s) and do not necessarily reflect the positions or policies of the American Bar Association, the Section of Litigation, this committee, or the employer(s) of the author(s).