IRS Publishes Final Regulations on Disallowance of Qualified Transportation Fringe Benefit Deduction

On December 7, 2020, the IRS published final regulations relating to the deduction of qualified transportation fringe (QTF) and commuting expenses. Effective for taxable years ending after December 31, 2019, the final regulations adopt the proposed regulations (published back in August 2020) with minimal changes. As background, the 2017 Tax Cuts and Jobs Act (TCJA) disallowed deductions for QTF expenses and deductions for certain expenses of transportation and commuting between an employee’s residence and place of employment (effective for amounts paid or incurred after December 31, 2017). Importantly, QTFs, up to indexed monthly limits ($270 for 2020), are still excludable from employees’ income. The TCJA also provided that a tax exempt organization’s unrelated business taxable income (UBTI) is increased by the amount of the QTF fringe expense that is nondeductible (for amounts paid or incurred after December 31, 2017).

Then, on December 20, 2019, Congress enacted the Further Consolidated Appropriations Act of 2020 (FCAA), which retroactively repeals those provisions of the 2017 TCJA back to the original TCJA enactment date. These final regulations address this retroactive elimination of the deduction for expenses relating to QTFs provided to employees, building off interim guidance published in 2018 and the 2020 proposed regulations. Relevant topics are addressed below.

Qualified Parking
As with the proposed regulations, the final regulations distinguish between qualified parking purchased from a third party and parking provided at an employer-owned or leased parking facility. When through a third party, the disallowed amount is generally the annual qualified parking cost paid to the third party. However, when through an employer-owned/leased facility, the disallowed amount may be determined using a general rule or via any of three simplified methods. Employers may choose the applicable method each year and for each parking facility.

Under the general rule, the employer calculates the disallowed deduction for each employee receiving qualified parking, using a reasonable interpretation of the statute. To be reasonable, the interpretation must: 1) be based on the expense paid/incurred, not on the benefit’s value to employees; 2) disallow deductions for reserved employee spaces; and 3) properly apply the exception for parking made available to the general public.

There are actually three simplified methods. The first is the “primary use” method, which requires the employer to calculate the disallowance for reserved employee spaces, determine if the exception for general public parking applies (and if not, calculate an allowance for reserved nonemployee spaces), and allocate the remaining expense as nondeductible to the extent employees use them during peak demand period. The second is the “cost per space method” (multiplying the cost per space of the employer’s parking by the total number of spaces used by employees during peak demand). The third is the “qualified parking limit” method (multiplying the qualified parking exclusion limit by the total number of spaces used by employees during peak demand or the total number of employees).

Vanpooling and Transit Expenses as QTFs
The final regulations also address vanpooling and transit expenses. Similar to qualified parking, where an employer pays a third party for qualified vanpooling or transit fringe benefits, the nondeductible amount is generally the amount paid. Conversely, if the employer provides these benefits in kind, the disallowed deduction must be calculated based on a reasonable interpretation of the statute (rather than on the value of the benefit to the employee).

Exceptions
Like so many rules, there are exceptions in certain circumstances that would preserve all or a portion of an employer’s deduction for QTFs. 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 QTFs. Also, expenses 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 (more than 50%) is not by the general public. Lastly, 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. Notably, this exception does not apply to benefits purchased under a compensation reduction agreement.

Tax-Exempt Organizations and UBTI
The TCJA also added a provision (Section 512(a)(7)) stating that a tax-exempt organization’s UBTI is increased by the amount of the QTF expense for which a deduction is not allowable under Sec. 274, effective for amounts paid or incurred after December 31, 2017. In December 2017, though, that TCJA provision was repealed, retroactive to the original date of enactment of the TCJA. Although Sec. 512(a)(7) was retroactively repealed, Sec. 274 and the final regulations still apply to a tax-exempt organization to the extent that the amount of the QTF expenses paid or incurred by an exempt organization is directly connected with an unrelated trade or business conducted by the exempt organization. In that case, the amount of the QTF expenses directly connected with the unrelated trade or business is subject to the disallowance, and thus disallowed as a deduction in calculating the UBTI attributable to that unrelated trade or business. Tax-exempt employers with questions on QTFs and UBTI should work with outside counsel.

Takeaways
Employers should be aware of the final regulations, and should work with their accounting team and/or outside tax counsel to determine appropriate next steps. Despite their complicated nature, the final regulations provide greater clarity on various QTF issues, and employers may find potentially meaningful opportunities to simplify the calculation of nondeductible expenses, which could result in cost savings. The final regulations are effective for tax years ending after December 31, 2019.

Final Regulations »