The status of qualified transportation fringe benefits

The Employer’s Road Map

Since 1985, the IRS has allowed employers to provide tax-free qualified transportation benefits to their employees. These benefits include parking, vanpooling, transit passes, and bicycle commuting expense reimbursement. Historically, employees were able to pay for these benefits using pre-tax dollars up to an annual maximum, and employers were able to take a tax deduction for their own contributions. The 2019 maximum contribution limit for qualified parking benefits is up to $265/month, and the combined limit for both transit passes and vanpooling expenses is also $265/month.

Congress Puts Up a Roadblock

When the Tax Cuts and Jobs Act (TCJA) passed in 2017, it generally left the pre-tax status of transportation fringe benefits for employees alone, but employers lost the ability to take tax deductions for employer-provided commuter or parking benefits.[1]  The TCJA also affected nonprofit companies, as it requires they include the cost of qualified transportation benefits in their unrelated business income (UBTI).  UBTI is a tax-exempt organization’s gross income that it earned from any unrelated trade or business that the organization regularly carries out, minus any allowable deductions.

Employers Try a Round-a-Bout

A number of practitioners suggested employers could work around the loss of the tax deduction by providing additional taxable compensation to employees contingent on the employees using it to elect transportation fringe benefits through a salary reduction arrangement (SRA).  Under this theory, the additional compensation remains deductible to the employer as wages and employees could exclude the additional compensation from taxable income by electing the benefit through the SRA instead of accepting the additional cash compensation. 

And Partially Succeed

On its face, the Internal Revenue Code (IRC) doesn’t appear to support an employer deduction under the proposed workaround[2] and language found in IRS Publication 15-B also seems to reject it.[3]    

The IRS resolved this in IRS Notice 2018-99 and will permit an employer to take a tax deduction for the value of transportation fringe benefits provided in excess of the exclusion limit ($265/month for 2019).[4]This excess is also taxable income to the employee, meaning the employee cannot exclude it by deferral through an SRA.  

Example 1

An employer provides $150/month in additional compensation to be used toward parking expenses in a parking garage adjacent to the employer’s office.  The amount provided does not exceed the monthly exclusion amount for 2019 ($265/month), so no portion of the $150/month may be deducted by the employer.  The amount provided is not taxable income to the employee.

Example 2

An employer provides $500/month in additional compensation to be used toward parking expenses in a parking garage adjacent to the employer’s office.  In 2019, the employer can deduct $235/month ($500 - $265) as additional paid wages.  This $235/month is also taxable income to employee(s).  It does not matter if the employee contributes through an SRA.

Note: 2019 IRS Publication 15-B still includes the seemingly contradictory language, but we believe the guidance in IRS Notice 2018-99 controls.

Which Road to Take?

Several states and localities require employers to provide transportation benefits to their employees.  When stakeholders raised concerns with the IRS over the TCJA’s effect on employers in these locations, the IRS responded that the TCJA’s reduction of the corporate tax rate beginning in 2018 should off-set losing the deduction.  Employers considering eliminating the benefit should review state and local laws (see State and Local Requirements below), as well as check the tax implications and weigh them against these benefits’ ability to attract and retain new employees.   

State and Local Requirements

Despite the TCJA’s tax deduction limitations, certain states and cities require employers to provide these benefits.  Employers operating in the following cities, counties, and/or states should be aware of their local transportation requirements.

[1] In a somewhat bizarre twist, the employer tax deduction for bicycle benefits remains (up to $20/month), but employees must include it in taxable income.  Employees also cannot pay for this benefit on a pre-tax basis through payroll deductions. 

[2] Specifically, the language of IRC Section 274(e)(2) doesn’t seem to support excluding the “earmarked’ transportation benefits as additional compensation because it doesn’t reference transportation expenses.

[3] Page 21 of IRS Publication 15-B states, “Section 13304 of P.L. 115-97 provides that no deduction is allowed for qualified transportation benefits (whether provided directly by you, through a bona fide reimbursement arrangement, or through a compensation reduction agreement) incurred or paid after 2017.”

[4] Tax-exempt entities also appear to be able to exclude this amount when calculating UBTI.