The Tax Cuts and Jobs Act of 2017 (TCJA) contained hundreds of changes to our tax law including Qualified Business Income Deductions, limits on business interest expense, limits on excess business losses, and major changes to the U.S. taxation of profits earned overseas. While much of the noise about the new tax law revolved around these items and others, less noise surrounded the part of the law which eliminates the deduction for Qualified Transportation Benefits.
The Internal Revenue Code (IRC) allows employers to offer certain non-taxable Qualified Transportation Fringe (QTF) benefits to their employees. These can include mass transit benefits, van pools, qualified parking and other commuter benefits, whether paid for directly by the employer, through a bona fide reimbursement plan or through a salary reduction agreement.
In a competitive job market, tax-free fringe benefits are an important part of employee recruiting and retention. While many fringe benefit provisions remain intact, as of January 1, 2018, the IRC generally provides “no deduction shall be allowed for the expense of any qualified transportation fringe as defined in section 132(f) provided to an employee of the taxpayer.”
Transit Passes and Parking
Under a salary reduction agreement, employees can exclude $260 per month for 2018 and $265 per month for 2019 from Federal, Social Security and Medicare taxes (less for S Corp employee owners and partners). Similar excludable amounts apply to employee parking. Employers are also exempt from Social Security, Medicare and FUTA payroll taxes on QTFs paid for through a pre-tax salary reduction agreement or parking exclusion. This has provided a strong incentive to encourage employers to offer salary reduction plans, particularly for mass transit and/or parking benefits. No changes have been made to this payroll tax reduction benefit. The change that hurts employers is the loss of the deduction through an addback to income on the employer’s income tax return.
There are only a few exceptions to this new law: 1) when the QTF is for a company owned or leased parking facility for which greater than 50% of the parking facility is used by the general public during normal business hours; 2) when the QTF expense is necessary for ensuring the safety of the employees (IRS Publication 15-B, page 21). 3) amounts that are taxable to the employee in excess of the above $260/$265 limitation. Where exceptions apply, amounts are still deductible to the employer.
While tax-exempt entities also benefit as employers from the payroll tax savings of QTFs under a salary reduction agreement, such entities are now required to increase their unrelated business taxable income and pay an Unincorporated Business Tax (“UBIT”) on those QTF benefits.
For parking provided by a third party, the amount paid to a third party for employee parking is disallowed or creates Unrelated Business Taxable Income (UBTI). The complexity of the parking disallowance rules become extreme when an employer owns or leases the property containing any parking spaces used for employee parking. Many costs generally associated with the ownership of said property, such as repairs and maintenance, utilities, insurance, property taxes, snow, leaf and trash removal, parking lot attendants, security, lease payments, etc., will be allocated between the employee and nonemployee portions, and between specifically assigned parking and non-specifically assigned parking.
In December of 2018, the IRS provided interim guidance regarding this issue and indicated its intention to publish proposed regulations determining the nondeductible parking expenses and other expenses for QTFs, as well as addressing issues related to the increase in UBTI for QTFs. Meanwhile, any reasonable method for allocating parking expenses between deductible and nondeductible use will be permitted. The notice specifically identifies certain methods as being unreasonable. You must first determine if there are parking spaces specifically reserved for employees. The cost of those spaces is generally disallowed as a deduction. If there are not, the notice provides many examples under alternative fact patterns on how the costs associated with non-specifically assigned employee and non-employee parking is determined.
What should you do now?
Businesses should consider updating their chart of accounts, to enable the identification/capture of costs associated with providing QTFs to their employees, in order to assist themselves and their accountants in properly determining the amount of nondeductible QTFs.
Businesses should also analyze what types of QTFs can reasonably fall under the exceptions mentioned above.
Often with flow-through entities, the partners or S corporation shareholders would be losing a deduction at the top 37% individual tax rate while the employees getting the benefit of tax-free fringes are on average in a much lower tax bracket. Businesses offering pre-tax transit plans may wish to consider offering alternative fringe benefits that remain tax deductible. Note that NJ, NYC, Washington DC and several CA cities require the offering of transportation fringe benefits when certain minimum employee thresholds are met.
While the TCJA has added an abundance of complexities to the tax law The Tax Warriors® at Drucker & Scaccetti are eagerly diving into them and are here to guide you through.