Taxation of In-Kind Benefits

Background

In general, only cash income is subject to the income tax. In-kind benefitsbenefits that are received as goods or services rather than as cashare not. Examples of in-kind benefits include public housing, the insurance value of Medicare coverage, and food assistance.

Taxing in-kind benefits would require taxpayers to make monetary payments on nonmonetary income. As a result, it would impose a significant burden on people with low and moderate incomes. Another frequent problem is the difficulty of determining an appropriate value of in-kind income, such as insurance benefits.

At the same time, the exclusion of in-kind benefits from taxation raises some concerns. First, excluding all in-kind benefits from taxation narrows the tax base, requiring higher tax rates on other forms of income. Many employer-provided benefits—including transportation benefits, flexible spending account contributions, and tuition assistance—are not subject to tax. Many people with low and moderate incomes do not have access to such benefits.

Another issue involves the exclusion for employer-sponsored health insurance. Many have argued that an unlimited exclusion for employer-provided health insurance creates an incentive to obtain more expensive coverage, offering no incentive for health care cost containment. To address this problem, the Patient Protection and Affordable Care Act imposed a 40 percent excise tax on “Cadillac” (overly generous) health insurance plans exceeding certain cost thresholds.

TAXATION OF IN-KIND BENEFITS: Policy

Medicare and other in-kind benefits

In this policy: FederalState

Policymakers should not tax the actuarial value of Medicare or the value of other in-kind benefits.

Other employer-sponsored benefits

In this policy: FederalState

Additional new limitations on the exclusions for other employer-provided benefits—such as life insurance, tuition, and parking—are a desirable method of broadening the tax base and making the income tax more progressive.

Health insurance

In this policy: FederalState

Eligibility for the exclusion for employer-provided health insurance should be determined based on the employer’s coverage rules.

When structured correctly, the exclusion for employer-sponsored health insurance may be an important method of encouraging health insurance coverage. Limiting the health insurance exclusion to amounts below some threshold, and using the revenue thus derived to finance health insurance for families and individuals with low incomes or who are uninsured, makes the tax system more neutral and equitable and may be a factor in slowing the growth of health care costs (see also Chapter 7, Health - Individual- and Employment-Based Group Plans, for discussion on implementation challenges).

Pensions

In this policy: FederalState

Lawmakers should maintain the tax-deferred status of employer-provided pensions as a critical way of promoting retirement savings.