Update on Qualified Transportation Benefits Under Tax Reform

Posted on Nov 28, 2018

By Jane M. Searing, CPA, M.S. Taxation

Note: This article, originally published on February 21, 2018, has been updated to include the latest developments regarding the Tax Cuts and Jobs Act.

Prior to passing the Tax Cuts and Jobs Act of 2017, certain transportation benefits and, in some rare cases, onsite athletic facility benefits were treated as tax exempt to employees — and tax deductible to employers. This is no longer the case.

Beginning January 1, 2018, for the benefits listed below, there has been a change in the tax law. Originally, the changes appeared to allow employers to determine the taxability of the employee benefits by whether the employer took a tax deduction for the cost of said benefits. As it turns out, this is not the way the law operates. The determinative factor is whether the benefit provided to the employee meets the definitions below. If it does, it is exempt income to the employee. If the employer pays for these benefits, the costs paid or incurred to provide these benefits is not deductible to a taxable employer, and the costs are converted to unrelated business income for a tax-exempt employer.

Transportation Benefit Changes as of 2018

The tax law made other changes causing many benefits to be taxable to employees. These are not included in this change. The only benefits included in this law change are:

  • Qualified transportation and commuting fringe benefits associated under Internal Revenue Code section 132(f), including:
    • Any transit pass; and
    • Transportation in a commuter highway transportation vehicle between the employee’s residence and workplace paid by the employer.

The sum of these two benefits’ fair market value may not exceed $260 per month. Anything over this amount is taxable to the employee.

  • Qualified parking – up to $260 per month. Anything over this amount is taxable to the employee.
  • Any on-premises athletic facility as defined in section 132(j)(4)(B), restricted to use by highly compensated employees.

The net effect of this change is more than just the lost value of the tax deduction on the benefits to the employer. The corporate tax rate was also decreased from 35% to 21%, while individual tax rates shifted only slightly.

What Should Employers Do?

There are a couple of decision points for employers. The IRS issued guidance in Publication 15B. The report advised that the use of a qualified salary reduction plan by employees to purchase qualified transportation benefits will result in the employer not being allowed to deduct the portion of the employee salary used for this purpose. Therefore, the only way for an employer to fund transportation benefits is to provide an unrestricted increase in salary and allow employees to use it for transportation benefits or any other purpose the employee chooses.

The following are modified examples from our previous article on this subject:

Overview: The value of the benefits is $100,000. The employer is a personal service corporation. The average employee is in the 25% marginal tax rate.

Option 1:

The employer continues to pay for qualified transportation benefits. There is no option of forgoing a deduction. The deduction is lost as a matter of law. The benefit is a tax-free fringe benefit to the employee.

  • Cost to employer: $100,000 cash for benefits and $21,000 in additional taxes paid due to loss of deduction = $121,000
  • UBI to the tax-exempt employer: $100,000
  • Benefit to U.S. Treasury: $21,000
  • Benefit to employees: $100,000
  • Cost to employees: $0

Option 2:

The employer no longer pays for the benefits but allows the employees to purchase benefits through a qualified salary reduction plan. Assume no increase in employee compensation.

  • Cost to employer: $21,000 in additional taxes paid due to loss of payroll deduction (The $100,000 of compensation was already paid so assumed no additional cost)
  • UBI to the tax-exempt employer: $100,000
  • Benefit to employee: $100,000
  • Cost to employees: $75,000
  • Net benefit to employees: $25,000
  • Benefit to U.S. Treasury: $21,000

Option 3:

The employer can gross up the compensation paid to employees and allow employees to pay for transportation benefits or use the additional compensation for any other purpose.

  • Cost to employer: $100,000
  • Benefit to employer: $21,000
  • UBI to the tax-exempt employer: $0
  • Net cost to employer $79,000
  • Benefit to employees: $100,000
  • Cost to employees: $25,000
  • Net benefit to employee: $75,000
  • Benefit to U.S. Treasury: $25,000 + $21,000 = 46,000

The least costly option to the employer is to stop paying for qualified transportation benefits but allow employees to use pre-tax dollars to purchase transportation benefits. The employer would lose a tax deduction for the portion of the salary the employee uses for the purchase of the qualified transportation benefits while still being out of pocket for the salary expense.

The least costly to the employee is for the employer to continue providing qualified transportation benefits.

The most beneficial for the U.S. Treasury, and ultimately the costliest for everyone except the tax-exempt employer, is if the employer grosses up salary and no longer provides qualified transportation benefits.

The most important highlight is the first decision point: Does the employer provide qualified transportation benefits? If the employer does, the costs paid or incurred will not be deductible to the employer. This is true whether paid directly or through a qualified salary reduction plan. The second decision point is whether to pay for the benefits directly or allow employees to pay through a salary reduction plan. However, in either scenario, the employer loses some amount of deduction, either the cost of the benefits or the salary deferral amount. Ultimately, each employer will have to examine the options and facts based upon its circumstances and do what is right for its organization and employees.

Questions?

Please contact Jane Searing if you have questions about how tax reform might affect your employee benefit plan or visit our Tax Cuts and Jobs Act page for additional resources.

© Clark Nuber PS, 2018. All Rights Reserved

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