Transit benefits can be a great employer-provided perk to employees, whether provided for mass transit or parking, and whether paid directly to transit and parking companies or to employees. As a result of recent federal legislation known as the Tax Cuts and Jobs Act (“Act”), however, employers may no longer deduct such transportation fringe benefits as their own deductible business expenses. Moreover, nonprofit employers that provide this employer-provided perk must report and pay tax on the value provided as taxable “unrelated business income.” On the other hand, employees may still contribute their own earned wages through a pre-tax salary reduction program. Confusing? Here are the key legal details and related employment adjustments that may be warranted in light of the Act’s passage, for both taxable and tax-exempt employers.
Fundamental Employment Fringe Benefit Concepts, Specific to Transportation
Fringe benefits are forms of compensation provided to employees for the performance of services, which are provided in addition to the employee’s stated wages. The general tax rule is one of inclusion. In other words, fringe benefits are taxable and must be included in the employee’s wages, unless they are expressly excluded under the Internal Revenue Code. If a fringe benefit is specifically excluded, then its economic dollar value likewise will not be subject to federal income tax withholding, social security, and Medicare. Section 132 of the Tax Code is the key tax provision, excluding a variety of fringe benefits including “qualified transportation” benefits.
Per Section 132(f)(1) of the Tax Code, the term “qualified transportation” includes the following: (A) transportation in a commuter highway vehicle, for work transit; (B) transit passes; and (C) qualified parking. A commuter highway vehicle is a vehicle that seats at least six adult passengers, for which transportation of employees to their work places is expected to account for at least 80% of the vehicle’s mileage, and in which at least half of the passenger seats are occupied by employees. A transit pass is any pass, fare card, or similar item entitling a person to ride, for free or at a reduced rate, on mass transit or in a vehicle that seats at least six adult passengers and is operated by a person in the business of transporting persons for pay or hire. Qualified parking includes parking provided to employees on or near business premises. These terms are all defined in Section 132(f)(5) of the Tax Code.
Prior to the Act’s passage, transportation fringe benefits could be deducted by employers as part of their ordinary business expenses, on their corporate tax returns. As a practical matter, however, this tax benefit affected only taxable employers, not tax-exempt organizations, since tax-exempt organizations generally are not, well, taxable.
No More (Taxable) Employer Deduction for Transportation Fringe Benefits
Simply put, the Act eliminated the employer-level deduction. More specifically, the Act denies employers a deduction for expenses related to transportation fringe benefits provided to its employees (unless the expenses are necessary for employee safety, which is a narrower and different category). Employers may still provide this transportation benefit, just as they may provide other perks with some economic value (taxable and otherwise) like office parties or tokens of appreciation. The transportation benefit just is not deductible to the employer anymore. This change thus may be pause for employer reevaluation.
Strange News for Nonprofit Employers
What about for nonprofit employers? Here, the tax plot thickens: the Act imposes an unrelated business income tax (“UBIT”) on nonprofit organizations for providing transportation fringe benefits. In other words, if a nonprofit employer uses some of its revenues to pay for employees’ transportation fringe benefits, then such revenues will be taxed to the employer. These nonprofit revenues would not otherwise be taxable, given the nonprofit’s tax-exempt status, but for this new tax twist thanks to the Act. This change is apparently meant to level the employer tax playing field, providing parity between taxable and non-taxable employers in terms of otherwise potentially taxable income to the employer. But it surely is one of the strangest UBIT twists (of which there are assuredly many).
By definition, unrelated business income is the income that a tax-exempt organization generates from (a) a trade or business that (b) is regularly carried on by the organization and that (c) is not substantially related to the organization’s exempt purposes. Prior to the Act, a tax-exempt organization’s unrelated business income was subject to UBIT at a tax rate determined under a marginal rate structure in which the lowest tax rate was 15% and the highest tax rate was 35%. The Act eliminates this marginal rate structure and imposes a flat rate of 21% on unrelated business income. So a tax-exempt organization’s expenses related to the provision of qualified transportation benefits will now be subject to the flat UBIT rate of 21%.
For tax-exempt organizations with very little or no unrelated business income, treating transportation fringe benefits as unrelated business income will likely result in new reporting and potential tax liability implications. More specifically, tax-exempt organizations with at least $1,000 of unrelated business income are required to file IRS Form 990-T, Exempt Organization Business Income Tax Return, along with payment of UBIT on net taxable income. If possible, tax-exempt employers would presumably like to avoid this tax reporting headache.
Limited Options Ahead for Both Taxable and Tax-Exempt Employers
What are good employers to do in the wake of these tax changes? First of all (deep breath), remember that employees’ transportation fringe benefits may still be excluded from their own taxable income, if transit benefits are provided by employers. In fact, thanks to the Act, the exclusion amount has now been increased to $260 per month for combined commuter highway vehicle transportation and transit passes, as well as to $260 per month for qualified parking. Any amount beyond these limitations must be included in employee income. Employees therefore may choose to allocate certain amounts of their wages as transportation benefits through a salary reduction payroll item, making such wages non-taxable to them.
What’s the difference ultimately? Pre-Act, employers had a full loaf of bread – employers didn’t count such benefit as “compensation,” the cost paid was a business deduction, and employees received it on a nontaxable basis. Post-Act, employers now have only some crumbs – employers have lost this deductible business expense, ostensibly in exchange for a now-lower 21% corporate tax rate. More specifically, if an employer chooses to provide the transit benefit as a non-compensatory benefit to employees, then its dollar value (a) is not deductible as a business expense to taxable employers, and (b) will be taxable under UBIT for nonprofit organizations tax exempt under 501(c).
One solution here, as part of financially rewarding their employees, is for both taxable and tax-exempt employers to discontinue transit benefits but, to be fair to employees, give them a commensurate raise. That approach would make up for employees’ loss of their transit benefit. Another option is for employers to continue the status quo: have a Section 132(f) transit benefit program and let employees claim such pre-tax transportation benefits. Consequently, business employers will have resulting tax liability because the benefits’ dollar value is no longer a deductible business expense under Section 274(a)(4) of the Code for businesses. Additionally, nonprofit employers now will be subject to UBIT liability under newly updated Section 512 of the Code. Please keep in mind too that in some locations like San Francisco and New York, employers are legally obligated to provide pre-tax transit benefits regardless of accompanying tax implications.
Tax regulations have not yet been issued for this somewhat startling (and perhaps unnecessarily complicated) federal tax change. So further clarity may be in the works. In the meantime, employers – and especially nonprofit employers – may want to rethink and rework their employee transit benefit programs.