IRS Proposes Regulations on Disallowance of Employer’s Deduction for Commuting Benefits

The IRS has proposed regulations implementing provisions of the Tax Cuts and Jobs Act (TCJA) that amended Code § 274 to make qualified transportation fringe benefits nondeductible for taxable years beginning after 2017 (see our Checkpoint article). (Qualified transportation fringes, up to indexed monthly limits ($270 for 2020), are still excludable from employees’ income.) The proposed regulations build on interim IRS guidance issued in 2018 that focused on the amount of nondeductible qualified parking expenses and the unrelated business taxable income (UBTI) that tax-exempt employers were required to recognize when they incurred such expenses (see our Checkpoint article). (Congress later repealed the UBTI provision for tax-exempt employers (see our Checkpoint article), but the disallowance of deductions remains relevant for tax-exempt organizations with unrelated trades or businesses.) The proposed regulations still concentrate on the disallowance of employer deductions for parking expenses, but they also address transportation in commuter highway vehicles (vanpooling) and transit benefits, and explain how certain exceptions allow some qualified transportation fringes to be deductible. Here are highlights:

• Qualified Parking. The proposed regulations draw the same fundamental distinction made in the IRS’s interim guidance between qualified parking purchased from a third party and parking provided at a parking facility owned or leased by the employer. When an employer obtains parking from a third party, the disallowed amount is generally the annual qualified parking cost paid to the third party. When the employer owns or leases the facility, however, the disallowed amount may be determined using a general rule or a simplified methodology. Employers may choose the applicable method each year and for each parking facility—i.e., there is no uniformity requirement.

  • General Rule. Employers using the general rule must calculate the disallowed deduction for each employee receiving qualified parking, using a “reasonable interpretation” of the statute. The interpretation must be one that (a) is based on the expense paid or incurred and not on the benefit’s value to employees, (b) disallows deductions for reserved employee spaces, and (c) properly applies the regulations’ exception for parking made available to the general public.
  • Simplified Methods. The proposed regulations describe three simplified methods to calculate the nondeductible amount of an employer’s qualified parking expenses. The “primary use” method closely resembles the four-step method that was deemed reasonable in the IRS’s interim guidance. Under this method, the employer must calculate the disallowance for reserved employee spaces; determine whether the exception for providing parking to the general public applies, and, if not, calculate an allowance for reserved nonemployee spaces (if any); and allocate the remaining expense as nondeductible to the extent employees use the remaining spaces during the peak demand period. An alternative “cost per space” method allows taxpayers to determine their nondeductible expense by multiplying the cost per space of their parking by the total number of spaces used by employees during the peak demand period. Finally, a “qualified parking limit” method allows the nondeductible expense to be determined by multiplying the qualified parking exclusion limit by the total number of spaces used by employees during the peak demand period (or the total number of employees). Certain special rules—including a rule for aggregating mixed parking expenses and a rule for aggregating parking spaces in a single geographic location—are only available under some of the methods.
• Vanpooling and Transit Expenses. As in the case of qualified parking, if an employer pays a third party for qualified transportation fringes in the form of vanpooling or transit benefits, the nondeductible amount is generally the amount paid. But if the employer provides these benefits in kind, the disallowed deduction must be calculated based on a reasonable interpretation of the statute (and not on the value of the benefit to the employee).
• Exceptions to Disallowance. The proposed regulations affirm that three exceptions may, in certain circumstances, preserve all or a portion of an employer’s deduction for qualified transportation fringes. An employer’s deduction generally will not be disallowed to the extent the expenses are treated as taxable compensation for withholding and other purposes because they exceed the exclusion for qualified transportation fringes. Expenses also may be deductible if they are for transportation or parking made available to the general public. This exception does not apply to reserved employee parking, and is limited if the “primary use” of the parking (i.e., more than 50%) is not by the general public. Finally, expenses may be deductible if the vanpooling, transit pass, or parking is sold to customers (including employees) in a bona fide transaction for full consideration. Importantly, the preamble explains that this exception does not apply to benefits purchased under a compensation reduction agreement: qualified transportation fringe expenses are disallowed “regardless of whether the benefit is provided by the employer in-kind, through a bona-fide cash reimbursement arrangement, or through a compensation reduction agreement.”
• Code § 274(l). Under the proposed regulations, the provision in Code § 274(l) denying a deduction for travel between home and work does not apply to expenditures for qualified transportation fringe benefits. Thus, this provision does not prevent a deduction for qualified transportation fringes when a deduction would otherwise be allowed (e.g., for qualified parking benefits treated as compensation because they exceed the qualified parking exclusion limit). Unlike qualified transportation fringes, deductions denied by Code § 274(l) are not allowed merely because those expenses are included in employees’ compensation.
• Reliance Pending Final Regulations. The regulations are proposed to be effective for taxable years beginning on or after the date they are finalized. In the meantime, employers may rely on the proposed regulations or on the 2018 interim IRS guidance.

EBIA Comment: With 14 definitions and exceptions to exceptions, this proposal is quite complex. And it does not materially expand deductions for qualified transportation fringe benefits—e.g., the IRS declined to apply the exception for services sold to customers to compensation reduction arrangements. But the proposed regulations do provide greater clarity on various issues, and employers may identify some potentially meaningful opportunities to simplify the calculation of nondeductible expenses. For more information, see EBIA’s Fringe Benefits manual at Section XX (“Qualified Transportation Plans”).

Contributing Editors: EBIA Staff.