IRS Proposed Rules Address TCJA's Elimination of Deduction for Qualified Transportation Fringe Benefit Expenses

Practical Law Legal Update w-026-1402 (Approx. 7 pages)

IRS Proposed Rules Address TCJA's Elimination of Deduction for Qualified Transportation Fringe Benefit Expenses

by Practical Law Employee Benefits & Executive Compensation

Disallowance of Employer Deduction Under TCJA

The Code generally excludes the value of qualified transportation fringe benefits (QTFBs) from an employee's gross income (26 U.S.C. § 132). QTFBs refer to:

Qualified parking.
Transit passes.
Vanpooling between an employee's residence and place of employment.

For 2018 to 2025, under the TCJA, bicycle commuting reimbursements are not considered a QTFB (see Practice Note, Fringe Benefits Under Code Section 132: Transportation and Other Benefits: Qualified Bicycle Commuting Reimbursements).

Effective for expenses paid or incurred beginning in 2018, the TCJA amended the Code to disallow a deduction for QTFB expenses provided by an employer to employees (26 U.S.C. § 274(a)). This change applies for expenses incurred for QTFBs whether they are provided:

By the employer in-kind.
Through a salary reduction election (see Practice Note, Cafeteria Plans).
Using a bona fide cash reimbursement arrangement.

However, deductions for expenses that fit within one of several exceptions under Code Section 274 are not disallowed (26 U.S.C. § 274(e)). As discussed below, certain of these exceptions are relevant in the QTFB context.

Interim Guidance on Parking Expenses (Notice 2018-99)

Notice 2018-99 provided interim methods for employers to use in determining the nondeductible amount for parking expenses. The guidance included categories of parking expenses that depend on whether an employer:

Pays a third party to provide parking for its employees.
Owns or leases a parking facility where employees park.

Regarding the latter category, Notice 2018-99 included a four-step process that the IRS viewed as a reasonable method for employers to use in calculating the deduction disallowance (see Legal Update, In TCJA Guidance, IRS Addresses How to Calculate Nondeductible Parking Expenses: Four-Step Method for Calculating Disallowance). This method involved:

Calculating nondeductible parking expenses associated with parking spots reserved for employees (as a percentage of total parking spots).
Determining whether any remaining spots are primarily used by the general public, in which case they may be deductible under an exception under Code Section 274(e).
Factoring the number of reserved nonemployee parking spots (for example, spaces reserved for partners, sole proprietors, and 2% shareholders of S-corporations), the expenses for which are nondeductible.
Determining the uses and resulting deductibility (or nondeductibility) of any spots not addressed under the above three steps.

Proposed Regulations Expand on Notice 2018-99

The IRS's proposed regulations would add new regulations addressing:

The TCJA's disallowance of deductions for QTFB expenses and the applicability of certain exceptions under Code Section 274(e) (26 U.S.C. § 274(e)).
Transportation and commuting expenses paid or incurred by an employer.

In a change from Notice 2018-99, the proposed regulations include a general rule and three simplified methods for calculating the amount of nondeductible expenses for when a parking facility is owned or leased by the employer. In addition, the proposed regulations:

Expand on Notice 2018-99 (which focused on parking expenses) to also address the deduction disallowance for expenses related to providing employees transportation in a commuter highway vehicle and transit pass QTFBs.
Generally apply the Notice 2018-99 interim guidance and applicable Code Section 274(e) exceptions to all QTFB expenses.

Employer Owns or Leases All or Part of Parking Facility

Consistent with Notice 2018-99, the proposed regulations would provide that if an employer pays a third party for its employee's QTFBs, the TCJA disallowance is generally the employer's total annual cost of QTFBs paid to the third party (see Legal Update, In TCJA Guidance, IRS Addresses How to Calculate Nondeductible Parking Expenses: Employer Pays a Third Party for Employee Parking Spots).

As to QTFB parking expenses, the proposed regulations include rules for employers that own or lease all (or part) of one or more parking facilities under which the TCJA disallowance may be determined using a general rule or any one of three simplified methods. The proposals include several changes to the definitions from Notice 2018-99 and some definitions that are altogether new.

General Rule and Three Simplified Methods (Parking Facilities)

The general rule under the proposed regulations would allow employers to calculate the disallowance using a reasonable interpretation of Code Section 274. Importantly, however, employers must:

Use expenses that are paid or incurred in providing QTFBs.
Allocate parking expenses to reserved employee spaces.
Correctly apply the exception for parking that is made available to the general public.

Under the first simplified method (called the "qualified parking limit methodology"), the disallowance amount is the product of:

The total number of spaces used by employees during the peak demand period (or, if preferred, the total number of the employer's employees).
The monthly per-employee exclusion limit for qualified parking (that is, $270/month for 2020) for each month in the tax year (26 U.S.C. § 132(f)(2); see Legal Update, IRS Announces 2020 Benefit Plan Limit Adjustments: Limits Related to Fringe Benefits and Other Code-Governed Health and Welfare Arrangements (Revenue Procedure 2019-44)).

The second simplified method (the "primary use methodology") would be largely derived from the four-step method under Notice 2018-99, with certain adjustments. The adjustments would include changes to existing defined terms and the addition of several new defined terms (at least some of which apply to one or more of the three methods). For example, the proposed regulations would:

Add a definition of "qualified transportation fringe."
Include a definition of "employee" that generally refers to common-law employees (and does not address the employment status of volunteers).
Change the definition of "general public" to include employees, partners, 2% shareholders of S-corporations, sole proprietors, independent contractors, clients, or customers of unrelated tenants in multi-tenant buildings (among other individuals).
Contain a definition of "parking facility" that excludes parking spaces on or near property used by the employee for residential purposes.
Add a definition of "geographic location" that means contiguous tracts or parcels of land owned or leased by an employer.

The proposed regulations also would define the term "mixed parking expense" and include a special rule for allocating certain mixed parking expenses for situations where expenses are not separated between parking facility and nonparking facility expenses.

Under the third simplified method (the "cost per space methodology"), the disallowance would be the product of:

The cost per parking space.
The number of available parking spaces to be used by employees during the peak demand period.

Special Rules Regarding QTFB Parking Expenses

The proposed regulations would include certain rules for parking expenses. For example, the regulations would permit employers to allocate 5% of their mixed parking expenses to the parking facility. However, this rule would only be available regarding certain of the methods described above. Another rule would permit employers to aggregate the number of parking spaces in a single geographic location (which, as noted, would be a defined term).

Standard Cost Per Parking Space

The proposed regulations would permit the maximum monthly dollar amount (under Code Section 132(f)(2), as adjusted for inflation) to be used as an estimate of an employer's monthly total cost per parking space. For 2020, this amount is $270 per month. As a result, employers could use the qualified parking limit methodology to calculate the disallowance. The amount would be the product of:

The monthly per employee limit on the exclusion ($270 per month).
The total number of spaces used by employees during the peak demand period.

(See General Rule and Three Simplified Methods (Parking Facilities).)

Expenses for Transportation in Commuter Highway Vehicles and Transit Passes

Under the proposed regulations, employer expenses for transportation in a commuter highway vehicle, a transit pass, or parking that are otherwise QTFBs (under Code Section 132), and that also are made available to the general public, would not be subject to the TCJA deduction disallowance if they are made available to the general public. As noted, "general public" would be a defined term under the proposed regulations that would include customers, clients, visitors, and others.

Request for Comments

The IRS seeks comments on all aspects of the proposed regulations, including (for example) whether additional rules are needed for significant variations in employee parking during the year because of national emergencies, such as the US outbreak of COVID-19. Written or electronic comments must be received by August 24, 2020.

Practical Impact

The proposed regulations include numerous clarifications (many in response to comments) and IRS position statements regarding the scope of nondeductible QTFBs under the TCJA's changes to Code Section 274. Many of these issues were the topic of IRS comment requests under Notice 2018-99. For example, the proposed regulations would provide that employer expenses for transportation in a commuter highway vehicle, transit pass, or parking that is otherwise a QTFB and that is sold to customers in a bona fide transaction for an adequate and full consideration in money or money's worth is not subject to the TCJA's deduction disallowance.

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