As the dust settles from the recent Congressional taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. and spending negotiations, policymakers and taxpayers are beginning to sort through the 887-page bill to figure out what it will mean for the 2016 tax year and beyond. Some of the provisions buried in the tax bill will have interesting consequences that have yet not been explored. For instance, one section of the bill that has not yet received enough attention is a provision that makes the Cadillac Tax deductible.
For some background – the Cadillac TaxThe Cadillac Tax is a 40 percent tax on employer-sponsored health care coverage that exceeds a certain value. The aim: to curb health-care cost growth, reduce favorable tax treatment of employer-provided insurance, and help fund the Affordable Care Act (ACA). It was repealed in late 2019 before taking effect. is an excise taxAn excise tax is a tax imposed on a specific good or activity. Excise taxes are commonly levied on cigarettes, alcoholic beverages, soda, gasoline, insurance premiums, amusement activities, and betting, and typically make up a relatively small and volatile portion of state and local and, to a lesser extent, federal tax collections. on employers that offer high-cost health insurance plans. The tax was designed to curb healthcare cost growth, roll back the favorable tax treatment of employer-provided insurance, and raise money to fund the Affordable Care Act. Nevertheless, it has long been unpopular with businesses, labor unions, and politicians on both sides of the aisle.
Initially, the Cadillac Tax was scheduled to begin in 2018. However, due to widespread dissatisfaction with the tax, the latest tax bill has pushed the start date to 2020. Some commenters have speculated that delaying the Cadillac Tax is the first step toward its ultimate demise, as Congress may simply choose to postpone the tax year after year.
But the recent tax bill doesn’t just delay the Cadillac Tax by two years; it also weakens the tax by making it deductible. Generally, businesses are not allowed to deduct their excise tax payments on their income tax returns. However, the latest tax bill carves out an exception for the Cadillac Tax, allowing businesses to deduct the amount that they pay in the Cadillac Tax from their taxable income.
What does this change mean? First, let’s imagine a business that is unable to deduct the Cadillac Tax on its income tax return. We’ll assume this business provides an employee with a healthcare plan with a $30,000 premium. Under the initial thresholds set by the Affordable Care Act, the first $27,500 of the premium would be exempt from the Cadillac Tax. Then, the remaining $2,500 would be subject to a 40 percent excise tax. Overall, the business would owe $1,000 as a result of the Cadillac Tax.
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Calculation of Cadillac Tax on a Business Providing a Family Plan with a $30,000 Premium |
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Total premium |
$30,000 |
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Portion of premium exempt from tax |
$27,500 |
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Portion of premium subject to tax |
$2,500 |
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Cadillac Tax owed |
$1,000 |
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Cadillac Tax rate |
40% (or $1000/$2500) |
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Note: this calculation uses an exemption threshold of $27,500, the applicable dollar limit for 2018. |
Now, what happens if the business is able to deduct the Cadillac Tax from its taxable incomeTaxable income is the amount of income subject to tax, after deductions and exemptions. For both individuals and corporations, taxable income differs from—and is less than—gross income. ? Assuming that the business faces a tax rate of 35% (the current U.S. corporate tax rate), every additional dollar of deductions will generally reduce the business’s income tax burden by 35 cents. So, the business will still face a Cadillac Tax of $1,000, but it will be able to deduct an additional $1,000 from its taxable income, which will reduce its income tax by $350. Overall, the Cadillac Tax will only lead to an additional $650 in tax liability for the business.
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Calculation of Cadillac Tax if the Tax is Deductible |
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Cadillac Tax owed (from above) |
$1,000 |
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Amount by which a business will be able reduce its income tax payments by deducting the Cadillac Tax |
-$350 |
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Total additional taxes resulting from the Cadillac Tax |
$650 |
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Cadillac Tax rate |
26% (or $650/$2500) |
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Note: this calculation assumes that a business faces a 35% marginal income tax rate and that each additional $1.00 of deductions leads to a $0.35 reduction of tax liability. |
From the examples above, we can draw an interesting conclusion: allowing businesses to deduct the Cadillac Tax is exactly equivalent to lowering the Cadillac Tax rate to 26 percent for businesses that pay corporate income taxes. By allowing a business to deduct the Cadillac Tax, Congress lowers the business’s additional tax obligation from $1,000 (or 40 percent of the $2,500 excess healthcare premium) to $650 (or 26 percent of the $2,500 excess premium).
However, there’s a catch: not all payers of the Cadillac Tax will be able to deduct it from their income tax returns. The Cadillac Tax applies to non-profit organizations and state and local governments – neither of which generally pay income taxes. Because these organizations have no income taxes to pay, they will be unable to deduct the Cadillac Tax, so their Cadillac Tax rate will remain at 40 percent.
All in all, making the Cadillac Tax deductible is more or less the same as lowering the Cadillac Tax rate to 26 percent for businesses that pay corporate income taxes and leaving it at 40 percent for tax-exempt organizations and state and local governments.
Was this a policy outcome that Congress intended? Did politicians really mean to lower the Cadillac Tax rate just for for-profit businesses? Unfortunately, it’s impossible to know the exact intent of legislators regarding a single provision in an 887-page bill. However, it is likely that, if the Cadillac Tax ever takes effect, Congress will face criticism for making the tax less burdensome on for-profit businesses than other organizations.
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