IRS Finalizes Transportation and Commuting Expense Regs

(Parker Tax Publishing December 2020)

The IRS issued an early release of final regulations under Code Sec. 274 to reflect legislative changes made by the Tax Cuts and Jobs Act of 2017 to qualified transportation fringe, transportation and commuting expenses. The final regulations, which have not yet been published in the Federal Register, (1) address the elimination of the deduction under Code Sec. 274 for expenses related to certain transportation and commuting benefits provided by employers to their employees, (2) provide guidance to determine the amount of such expenses that is nondeductible, and (3) apply certain exceptions under Code Sec. 274(e) that may allow such expenses to be deductible. T.D. 9939.

Background

Code Sec. 274 generally limits or disallows deductions for certain expenditures that otherwise would be allowable under Code Sec. 162(a) as ordinary and necessary expenses paid or incurred during the tax year in carrying on any trade or business. The Tax Cuts and Jobs Act of 2017 (TCJA) added Code Sec. 274(a)(4) to disallow a deduction for the expense of any qualified transportation fringe (QTF) provided to an employee of the taxpayer, effective for amounts paid or incurred after December 31, 2017. TCJA also added Code Sec. 274(l), which provides that no deduction is allowed for any expense incurred for providing any transportation, or any payment or reimbursement, to an employee of the taxpayer in connection with travel between the employee's residence and place of employment, except as necessary for ensuring the safety of the employee, effective for transportation and commuting expenses paid or incurred after December 31, 2017.

Code Sec. 132 generally excludes from employees' gross income the value of certain fringe benefits. Code Sec. 132(a)(5) generally provides that gross income does not include any fringe benefit that qualifies as a QTF under Code Sec. 132(f). QTFs are defined in Code Sec. 132(f)(1) to mean any of the following provided by an employer to an employee: (1) transportation in a commuter highway vehicle between the employee's residence and place of employment, (2) any transit pass, (3) qualified parking, and (4) any qualified bicycle commuting reimbursement. Code Sec. 132(f)(2) provides that the amount of QTFs provided by an employer to any employee that can be excluded from gross income under Code Sec. 132(a)(5) cannot exceed a maximum monthly dollar amount, adjusted for inflation. The adjusted maximum monthly excludable amount for 2020 is $270.

Code Sec. 274(e) enumerates nine specific exceptions to Code Sec. 274(a), three of which - Code Sec. 274(e)(2), (e)(7), and (e)(8) - are relevant for QTFs. Deductions for expenses that are within any of these three exceptions are not disallowed under Code Sec. 274(a)(4). Code Sec. 274(e)(2) applies to expenses for goods, services, and facilities, to the extent that the expenses are treated by the taxpayer as compensation and as wages to its employees. Code Sec. 274(e)(7) applies to expenses for goods, services, and facilities made available by the taxpayer to the general public. Code Sec. 274(e)(8) applies to expenses for goods or services (including the use of facilities) which are sold by the taxpayer in a bona fide transaction for an adequate and full consideration in money or money's worth.

In June, the IRS issued proposed regulations (REG-119307-19) to implement the TCJA amendments to Code Sec. 274. The proposed regulations restated the statutory rules under Code Sec. 274(a)(4), defined relevant terms, and provided a general rule and three simplified methodologies to determine the amount of nondeductible parking expenses when a parking facility is owned or leased by the taxpayer. Additionally, the proposed regulations included rules addressing the deduction disallowance for expenses related to providing employees transportation in a commuter highway vehicle and transit pass QTFs. Finally, the proposed regulations applied the applicable exceptions in Code Sec. 274(e) to all QTF expenses.

Final Regulations

Qualified Transportation Fringe: The final regulations adopt the proposed regulations' definition for the term "qualified transportation fringe." The definition is based on Code Sec. 132(f)(1), except that it does not include qualified bicycle commuting reimbursements. Although Code Sec. 132(f)(1) includes qualified bicycle commuting reimbursements as a QTF, Code Sec. 132(f)(8) provides that the inclusion of qualified bicycle commuting reimbursements in the definition of a QTF is suspended for tax years beginning after December 31, 2017, and before January 1, 2026. Accordingly, for such tax years, qualified bicycle commuting reimbursements are not excluded from an employee's income as a QTF. Because qualified bicycle commuting reimbursements are not QTFs, deductions for qualified bicycle commuting reimbursements are not disallowed under Code Sec. 274(a)(4) for tax years beginning after December 31, 2017 and before January 1, 2026.

Calculation of Disallowance of QTF Parking Expenses: Like the proposed regulations, the final regulations provide that if a taxpayer pays one or more third parties an amount for its employees' QTFs, the Code Sec. 274(a)(4) disallowance is equal to the taxpayer's total annual cost for the QTFs paid or incurred to third parties. The IRS determined that amounts paid to a third party for qualified parking should be disallowed regardless of actual employee use of the spaces because the taxpayer paid or incurred the expense for its employees' QTFs regardless of employee use. If instead, the taxpayer owns or leases a parking facility, the final regulations continue to provide that a taxpayer may use the general rule or choose any of the following three simplified methodologies (i.e., the qualified parking limit methodology, the primary use methodology, or the cost per space methodology) for each parking facility to determine the Code Sec. 274(a)(4) disallowance for each tax year. The general rule and three simplified methodologies are substantially the same as those provided in the proposed regulations, with the following modifications. Consistent with the proposed regulations, under the general rule, taxpayers may calculate the disallowance based on a reasonable interpretation of Code Sec. 274(a)(4), as long as the taxpayer's methodology does not use the value of a QTF instead of its expense, fail to allocate parking expense to reserved employee spaces, or improperly apply the exception for qualified parking made available to the public (for example, by treating a parking facility regularly used by employees as available to the public merely because the public has access to the parking facility).

For the qualified parking limit methodology, the final regulations are consistent with the proposed regulations and provide that the maximum monthly dollar amount under Code Sec. 132(f)(2), adjusted for inflation, may be used as a simple estimate of the taxpayer's monthly total cost per parking space. The adjusted maximum monthly excludable amount for 2020 is $270 per employee. Taxpayers using the qualified parking limit methodology may determine the disallowance simply by multiplying the Code Sec. 132(f)(2) monthly per employee limitation on the exclusion by the total number of spaces used by employees during the peak demand period. Alternatively, taxpayers using this methodology may instead multiply the Code Sec. 132(f)(2) monthly per employee limitation on the exclusion by the total number of the taxpayer's employees. Under Code Sec. 274(e)(2), the Code Sec. 274(a)(4) disallowance for QTFs does not apply to the extent that a QTF is treated as compensation to an employee on the taxpayer's return and as wages to the employee. Under the final regulations, as in the proposed regulations, a taxpayer using the qualified parking limit methodology who has monthly expenses per parking space exceeding the Code Sec. 132(f)(2) monthly per employee limitation on the exclusion can deduct those excess expenses without regard to how much (if any) of the value of the parking space to the employee exceeds the Code Sec. 132(f)(2) monthly per employee limitation on exclusion. However, the qualified parking limit methodology can be used only if the value of the QTF, to the extent it exceeds the sum of the amount paid (if any) by the employee for the QTF and the applicable statutory monthly limit in Code Sec. 132(f)(2), is included on the taxpayer's federal income tax return as originally filed as compensation paid to the employee and as wages to the employee for purposes of federal income tax withholding rules.

The second simplified methodology, the "primary use methodology," is largely based on the method deemed reasonable in Notice 2018-99 and modified in response to comments received. Special rules for allocating certain mixed parking expenses and aggregating parking spaces by geographic location may be used with the primary use methodology and this method was adopted in the final regulations without change.

Under the final simplified methodology, the cost per space methodology, the proposed regulations provided that employers would calculate the disallowance by multiplying the cost per parking space by the number of available parking spaces to be used by employees during the peak demand period. However, a practitioner pointed out that a taxpayer using the cost per space methodology calculates the disallowance of deductions for QTF parking expenses by multiplying the cost per space by the total number of "available parking spaces" used by employees during the peak demand period rather than the "total parking spaces" used by employees. The practitioner suggested that "total parking spaces" should be used instead of "available parking spaces" because reserved spaces are excluded from the definition of "available parking spaces." The IRS agreed with this suggestion and modified the cost per space methodology provided in the proposed regulations by specifying that "total parking spaces" is used to calculate the disallowance under the final regulations. In addition, the final regulations clarify that the cost per space calculation may be performed on a monthly basis.

Certain QTF Expenses Treated as Compensation under Code Sec. 274(e)(2): Code Sec. 274(e)(2) provides an exception to Code Sec. 274(a) for expenses for goods, services, and facilities, to the extent that the expenses are treated by the taxpayer, with respect to the recipient of the entertainment, amusement, or recreation, as compensation or wages to its employees. Because Code Sec. 132(a)(5) excludes the value of QTFs from an employee's gross income up to the limitations on exclusion provided by Code Sec. 132(f)(2), the proposed regulations provided that the exception in Code Sec. 274(e)(2) does not apply to expenses paid or incurred for QTFs the value of which (including a purported value of zero) is excluded from an employee's gross income under Code Sec. 132(a)(5). The proposed regulations further provided that Code Sec. 274(e)(2) applies to expenses paid or incurred for QTFs, the value of which exceeds the sum of the amount, if any, paid by the employee for the fringe benefits and any amount excluded from gross income under Code Sec. 132(a)(5), if treated as compensation on the taxpayer's federal income tax return as originally filed and as wages to the employee for purposes of federal income tax withholding.

Under Reg. Sec. 1.61-21(b)(1), an employee must include in gross income the amount by which the fair market value of the fringe benefit exceeds the sum of the amount paid for the benefit by or on behalf of the recipient and the amount, if any, specifically excluded from gross income under the Code. Thus, in the case of reimbursements by a recipient, the amount of the reimbursement is taken into account in determining the amount properly includible in the recipient's income and does not affect the taxpayer's ability to use the exception in Code Sec. 274(e)(2).

To prevent taxpayers from inappropriately claiming a full deduction under Code Sec. 274(e)(2) by including a value that is less than the amount required to be included under Reg. Sec. 1.61-21, the proposed regulations provided that the exception in Code Sec. 274(e)(2) would not apply to expenses for QTFs for which the taxpayer calculates a value that is less than the amount required to be included in gross income under Reg. Sec. 1.61-21. Practitioners argued this rule was unduly harsh given the difficulty in determining the value of a fringe benefit under Reg. Sec. 1.61-21 and the possibility of good faith errors. The IRS agreed and revised the rules to allow a taxpayer to apply Code Sec. 274(e)(2) even if the taxpayer includes less than the proper amount in compensation and wages as required under Reg. Sec. 1.61-21. In such a case, however, the amount of a taxpayer's deduction is limited to the amount included in compensation and wages, taking into account the amount, if any, reimbursed to the taxpayer by the employee (i.e., the "dollar-for-dollar" methodology). The final regulations also provide that if the value of a QTF exceeds the monthly per employee limitations on exclusion provided by Code Sec. 132(f)(2) ($270 per employee for 2020), so that only a portion of the value is included in the employees' wages, the taxpayer may apply Code Sec. 274(e)(2). However, in this case, the taxpayer must use the dollar-for-dollar methodology.

Safety of an Employee: The proposed regulations also defined the term "safety of the employee," referencing the description of a bona fide business-oriented security concern in Reg. Sec. 1.132-5(m). Practitioners suggested that the proposed rules for determining when transportation provided by an employer is necessary for the safety of the employee were too narrow and should be expanded to apply beyond a bona fide business-oriented security concern in Reg. Sec. 1.132-5(m). The practitioners suggested that the final regulations should instead define "safety of the employee" by reference to Reg. Sec. 1.61-21(k)(5), which provides that unsafe conditions exist if a reasonable person would, under the facts and circumstances, consider it unsafe for the employee to walk to or from home, or to walk to or use public transportation at the time of day the employee must commute. One of the factors indicating whether it is unsafe is the history of crime in the geographic area surrounding the employee's workplace or residence at the time of day the employee must commute. The IRS agreed with the suggestion and the final regulations clarify that a transportation or commuting expense is necessary for ensuring the safety of the employee if unsafe conditions, as described in Reg. Sec. 1.61-21(k)(5), exist for the employee.

Temporary or Occasional Place of Employment: A practitioner suggested that temporary or occasional places of employment should not be considered an employee's place of employment for purpose of Code Sec. 274(l) and pointed to prior guidance issued by the IRS as well as to case law that provides that travel to a temporary place of employment is not treated as commuting. The IRS agreed with this comment and thus modified the final regulations to explain that temporary or occasional places of employment are not an employee's place of employment under Code Sec. 274(l). However, the final regulations provide that an employee must have at least one regular or principal place of business.

Effective Date

The final regulations apply to tax years beginning on or after the date the regulations are published in the Federal Register. However, taxpayers may choose to apply Reg. Sec. 1.274-13(b)(14)(ii) of these final regulations to tax years ending after December 31, 2019.

Taxpayers may continue to rely on Prop. Reg. Sec. 1.274-13 through Prop. Reg. Sec. 1.274-14 or the guidance provided in Notice 2018-99 for parking expenses, other QTF expenses, and transportation and commuting expenses, as applicable, paid or incurred in tax years beginning after December 31, 2017 and before the date the final regulations are published in the federal register.

For a discussion of the tax treatment of QTF benefits, see Parker Tax ¶123,140.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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