Qualified Transportation Fringe Benefits
The New Law Imposes Big Changes to Employers’ Qualified Transportation Benefits.
One of the biggest unexpected surprises in the new tax law is the requirement that both for- profit and tax exempt organizations will no longer be allowed to expense transportation fringe benefits. In fact, tax-exempt entities are now required to report as unrelated business income (UBI) amounts paid or incurred for qualified transportation fringe benefits. These expenses include parking costs, as well as expenses related to traveling to work and back on subways, buses, or other similar commuter transit systems. (This rule, pertaining to tax exempt entities, was included in the tax law to maintain parity with for-profit organizations that are no longer able to deduct such expenses).
In March 2018, the IRS issued Publication 15-B, “Employer’s Tax Guide to Fringe Benefits.” Many tax professionals thought the law couldn’t possibly apply to employee deferrals of wages, reasoning that these were the employees’ own wages and that there was no benefit deduction to be disallowed. The new guide specifically states that qualified transportation fringe benefits include all such benefits regardless of who is paying! This will mean that for-profit companies will only be entitled to an expense if the employee includes the fringe in W-2 income.
The guide confirmed the non-deductibility of qualified transportation benefits, whether provided directly by the company, through a bona fide reimbursement arrangement, or through a compensation reduction agreement. Pre-tax deferrals through cafeteria plans are a type of compensation reduction agreement. Once the employee decides to convert their compensation into a payment of these benefits, the amount paid for these benefits through the employee’s pay is not deductible to a for-profit corporation. Under the new tax act, this appears to require tax exempt organizations pick up these amounts as taxable income and pay tax at the applicable corporate tax rates.
In summary, any situation where an employee receives a nontaxable qualified transportation benefit, whether paid by themselves through a payroll deduction, or provided by an employer who treats it as a nontaxable benefit to the employee, will create UBI to a tax exempt employer, which will be taxed at the regular corporate tax rates. Starting in 2018, the corporate tax rate will be a flat 21%. For those for-profit businesses, unless such benefits are included in employees’ payroll, these expenses will no longer be deductible.
Furthermore, regardless of when a business’ tax year-end is, these rules apply to amounts incurred or paid since January 1, 2018. Therefore, fiscal year-end tax exempt entities (i.e., 3/31/18 and 6/30/18) will need to plan on including these as UBI for the current year and will likely be required to file a 2017 Form 990-T and pay income tax using a blended tax rate. For-profit businesses will need to plan to modify payroll for employees who previously took advantage of these fringes.
Every for-profit or tax exempt organization should examine its specific fact pattern to determine if any changes can be made to the benefit offering in order to mitigate negative tax consequences. In many cases, employers may choose to adapt their plan offerings to address the added tax costs. (It should be noted that in some jurisdictions, it is mandatory for certain sized companies to provide access to these tax-free benefits for their employees, which limits the ability to eliminate such a benefit if desired. For example, the District of Columbia requires any employer with more than 20 employees to provide either 1) an employee-paid pre-tax benefit, 2) an employer- paid direct benefit, or 3) employer-provided transportation.)