Negative impact on both for profit and not-for-profit businesses
The new tax law referred to as the Tax Cuts and Jobs Act (TCJA) made substantial changes to business deductions for expenditures viewed to be inherently personal in nature. Deductions for meals and entertainment expenses were changed, as were deductions for qualified transportation fringe benefit (QTFB) expenses. As a result, QTFB expenses are not deductible for amounts incurred and paid after Dec. 31, 2017 and through Dec. 31, 2025; however, QTFB amounts remain excludible from an employee's income. With this new reality, businesses and tax advisors started to think about new arrangements that might accomplish the same tax result for these expenses that existed before the TCJA. This prompted additional guidance from the IRS.
The IRS recently issued guidance on QTFB in an unusual place. Instead of publishing an announcement, notice, or other form of guidance on this subject, the IRS updated Publication 15-B, "Employer's Tax Guide to Fringe Benefits," to clarify questions on the elimination of the deduction for qualified transportation benefits.
The new guidance addresses two questions central to transportation benefits that businesses and tax planners were asking:
- Can a QTFB plan be used to effectively preserve the business deduction, and
- Will the elimination of the deduction result in income subject to the Unrelated Business Income Tax (UBIT) for not-for-profit (NFP) entities?
Impact on the For-Profit Sector
To understand the context of these two questions, one should have some background on potential remedies that tax planners have been advocating.
A QTFB includes a variety of items, notably "qualified parking." Qualified parking means parking provided to an employee on or near the business premises of the employer, or on or near a location from which the employee subsequently commutes via a secondary manner (mass transit terminal, commuter highway vehicle, or carpool). A QFTB also includes a "transit pass," which means any pass, token, farecard, voucher, or similar item entitling the person to transportation using mass transit facilities or from any person in the business of transporting persons for hire in an eligible vehicle.
Essentially, tax planners proposed that an employer create a QTFB plan to which employees would contribute and that would provide for parking or other transportation expenses. These employee contributions would be funded by a salary increase. This is a subtle but important funding distinction when contrasted with historical funding arrangements, where businesses historically funded QTFB plans with general funds. In the proposed arrangement, the employee's actual take home pay would not increase, because the employee would enter into a salary reduction agreement that would divert the increase to the QTFB plan. The strategy was that the employer would deduct the amount that was diverted to the QTFB plan as wages, effectively preserving the now-eliminated deduction for QTFB expenses.
The new guidance in Publication 15-B answers the first of these questions. It clarifies that this is not a viable planning strategy, by stating "no deduction is allowed for qualified transportation benefits (whether provided directly by you, through a bona fide reimbursement arrangement, or through a compensation reduction agreement) incurred or paid after December 31, 2017." This clearly derails the proposed workaround, as the deduction is lost even though the QTFB plan is funded through employee wages.
Impact on the Not-for-Profit Sector
Shifting focus to NFP entities, the TCJA provides that certain fringe benefits which are not deductible under the TCJA (such as QTFB expenses) also increase income subject to UBIT. This was clarified by Janine Cook, IRS deputy associate chief counsel, on March 23. In her remarks she stated, "[I]f an employer effectively wants to give more cash to their employees so that they can pay for their parking or metro on a pretax basis, that is still a qualified transportation fringe benefit, it is not additional compensation." As a pre-tax benefit, the amounts paid as a QTFB would fall under the for-profit deduction limitation and the new UBIT fringe benefit rules. As such, the additional income subject to UBIT is taxable at 21%. This treatment puts NFPs in a comparable position to for-profit entities after the elimination of the deduction.
However, many smaller NFPs will face an additional challenge, as providing qualified transportation fringe benefits will result in the requirement to file Form 990-T, "Exempt Organization Business Income Tax Return." Previously these smaller NFPs did not have to file this form as they did not have income subject to UBIT. This complex form can be daunting for those completing it for the first time, and some practitioners have suggested that the IRS should issue guidance and a simplified form for NFPs filing solely due to the payment of QTFBs.
There are two other areas of concern for NFPs with income subject to UBIT as a result of QTFB expenses. The TCJA separately made a change to the manner in which the UBIT is calculated, where organizations with more than one trade or business must compute the UBIT separately with respect to each trade or business. The means that businesses operating at a loss cannot offset positive income from different businesses, and conceivably this will silo the income resulting from any QTFB expenses. Secondly, the for-profit sector widely regards the corporate tax rate reduction to 21 percent as a favorable measure, but NFPs may not see it the same way. This is because income subject to UBIT often is relatively small, which qualified for the 15 percent graduated corporate tax rate under pre-TCJA law. Because TCJA provides for a flat 21 percent tax rate, many NFPs actually will experience a tax increase. The 21 percent rate will apply to any income subject to UBIT from QTFB expenses.
Summary
Most analysts believe that employers will continue their practice of providing employees with transportation fringe benefits, despite the changes under TCJA. These analysts cited the relatively small added cost, particularly when compared to the amount of value these benefits have to employees. Also, some metropolitan areas also require that employers provide transportation benefits. These cities include the San Francisco Bay area, New York City, and Washington D.C.
For information and guidance on how the elimination of the deduction for QTFB expenses may affect your for-profit or NFP business, contact your local CBIZ MHM tax professional.
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