The Tax Cuts and Jobs Act of 2017 made a number of changes to the taxation of employer-provided fringe benefits. In one such change, the Act reversed a previous tax benefit by providing that employers would no longer by permitted to take a deduction for the expense of providing “qualified transportation fringe” benefits to employees. In what has been billed as an attempt to create parity between for-profit and tax-exempt entities, the Act also provided that the unrelated business taxable income (UBTI) of tax-exempt organizations would be increased by any amount paid or incurred by an employer for the provision of qualified transportation fringe benefits to its employees. (Yes, you read that correctly: For tax-exempt organizations, the Act effectively imposed a tax on an expense.)
While the changes made by the Act were relatively straightforward, the methodology for implementing the changes remained somewhat opaque. In December of 2018, however, in an effort to ease some of this uncertainty, the IRS released interim guidance in Notice 2018-99 to assist employers in determining the amount of qualified transportation fringe benefits – specifically, those related to parking expenses – that are now nondeductible. For tax-exempt organizations, the guidance details how to calculate the accompanying increase such organizations should include in their UBTI.
The Deduction Disallowance
Before the Act, employers were permitted a deduction for the expense of providing “qualified transportation fringes” to their employees. As defined in Code section 132(f), qualified transportation fringes include: “(a) transportation in a commuter highway vehicle if such transportation is in connection with travel between the employee’s residence and place of employment, (b) any transit pass, (c) qualified parking, [and] (d) any qualified bicycle commuting reimbursement.” Qualified parking, in turn, is “parking provided to an employee on or near the business premises of the employer or on or near a location from which the employee commutes to work[.]”
From a tax perspective, these benefits were favorable to both the employer and the employee. The for-profit employer could take a deduction for the expense of providing the benefit, and the employee could exclude the value of the benefit from his or her gross income (up to an indexed limit). Broadly speaking, the Act eliminated the employer deduction and left the employee exclusion intact. (On the good side, the Act did suspend the employee income exclusion for qualified bicycle reimbursements up to $20 each month. Similarly, it permits for-profit employers to take a deduction for the provision of qualified bicycle commuting reimbursements. Both provisions are in force only until January 1, 2026.)
The Act created Code section 274(a)(4), which provides that employers may no longer take a deduction for the expense of providing a qualified transportation fringe to employees. This rule applies regardless of how the benefit is provided – that is, regardless of whether it is provided via a reimbursement agreement or via a compensation reduction agreement.
Code section 274(e) provides a number of exceptions to the general rule in section 274(a). If an employer meets one of these exceptions, it may continue to take a deduction for the expense of providing a qualified transportation fringe. The interim guidance highlights two of these exceptions. First, an employer may take a deduction for any such expense that exceeds the employee gross income exclusion limit (which is a dollar amount that increases with the cost of living) and is, therefore, included in such employee’s compensation and wages. Second, an employer may continue to take a deduction for the expense of providing parking to customers and the general public. Of the various forms a qualified transportation fringe may take, it is perhaps most difficult to calculate the expense of providing qualified parking to employees. Often, employers will own or lease a parking facility that is used by both the general public and its employees. As seen above, employers may continue to take a deduction for the expense of providing parking to the general public. How then, should employers calculate the precise portion of such total parking expenses that is attributable only to the provision of parking to employees?
Notice 2018-99 focuses primarily on this issue. In a series of calculation steps, the IRS sets forth a safe harbor method for determining the expense of providing parking for employees – and, accordingly, for determining the amount of the new deduction disallowance for such expenses.
How to Calculate the Amount of Parking Expenses
The interim guidance provides safe harbor methods for two common arrangements: (1) employers that pay third parties for qualified parking expenses and (2) employers that own or lease all or a portion of a parking facility.
Employer Pays Third Party for Parking
If the employer pays a third party for the provision of employee parking spots, the approved methodology for calculating the expense of providing qualified parking (and thus the new deduction disallowance) is relatively simple: The expense is the amount the employer pays to the third party. This amount is capped by the indexed employee gross income exclusion limit. In 2018, this limit was $260 per month. For 2019, the indexed limit goes up for cost of living to $265 per month. Employers may continue to deduct any amount paid to a third party that exceeds the employee gross income exclusion limit.
Example
In 2018, Employer A paid Third Party N $11,200 per month for 40 employee parking spots. The cost per employee spot is $280/month. Each employee may only exclude $260 from gross income each month, but such amount is not deductible by Employer A. Employer A may, however, continue to deduct the $800 of the monthly expense that exceeds the $260 per month that is excluded from income by the employees: ($11,200 – ($260×40)).
Employer Owns or Leases All or a Portion of a Parking Facility
Generally speaking, employers that own or lease all or a portion of a parking facility may calculate the deduction disallowance using any reasonable method. For these purposes, the term “parking facility” includes indoor and outdoor parking garages, parking lots, and other parking structures. When calculating the deduction disallowance, employers should take into account their “total parking expense.” This term is broad and looks at all expenses related to the provision and maintenance of parking. It includes expenses such as any rent payments, repair costs, utilities, insurance, property taxes, trash removal and cleaning, landscaping, security expenses, and payments to parking area attendants.
An encouraging note for employers that own a parking facility: The interim guidance clarifies that depreciation will not be considered a “parking expense” that may be counted when determining the total parking expense or deduction disallowance.
Although the interim guidance encourages use of any reasonable method for determining the deduction disallowance, it also sets forth a safe harbor method for the calculation. This method involves four steps, many involving a series of sub-steps. Each is summarized below.
Pre-step
Determine the amount of total parking expenses and the total number of parking spots. For this purpose, employers may aggregate parking spots and expenses in one city or geographic location. Employers may not aggregate across cities or geographic locations.
Step 1: Calculate the Disallowance for Reserved Employee Parking Spots
First, identify the number of parking spots in the parking facility that are exclusively reserved for employees. Parking lots may be reserved for employees through the use of specific signage or limited access (such as a gate that opens only with a special key card). Second, determine the percentage of reserved employee spots in relation to the total parking spots in the parking facility. Third, multiply that percentage by the employer’s total parking expenses for that parking facility. The resulting amount counts toward the total deduction disallowance.
Employers that currently have reserved employee spots can avoid this outcome by decreasing or removing all reserved employee spots by March 31, 2019. If timely removed, employers may treat those parking spots retroactively to January 1, 2018.
Step 2: Determine the Primary Use of the Remaining Parking Spots
This step asks whether the primary purpose of the remaining, non-reserved parking spots is to provide parking spots to the general public. If more than 50 percent of a parking facility’s estimated or actual usage is by the general public, this its primary use is the provision of parking to the general public. Usage should be measured during typical business hours on a typical business day. For nonprofit organizations, usage should be measured during the typical hours of the organization’s activities on a typical day. Parking spots that are empty and that are not reserved for employees may be treated as provided to the general public. If usage varies depending on the day or week, employers should use any reasonable method to find primary use.
If the primary use of the remaining parking spots is the provision of parking to the general public, then the employer may take a deduction for the remaining total parking expenses (and may, therefore, discontinue the analysis at this step). That deduction is equal to the total parking expense, minus the disallowed amount determined in Step 1.
If the primary use of the remaining spots is not in the provision of parking to the general public, then the employer must continue calculating the total deductions disallowance.
Step 3: Calculate the Deduction Allowance for Reserved, Nonemployee Spots
For parking facilities that do not primarily provide parking to the general public, employers must next calculate the number of spots in the parking facility that are exclusively reserved for “nonemployees”. This term includes partners, sole proprietors, 2-percent-or-grater shareholders of S corporations, and the general public. If there are no such reserved parking spots, the employer may move to Step 4. Parking spots may be reserved for nonemployees in much the same way as they may be reserved for employees – generally, through specific signage or limited access.
Importantly, employers may continue to take a deduction for expenses incurred for parking spots reserved for nonemployees. To calculate the amount of this deduction allowance, employers should begin by determining the percentage of parking spots that are reserved for nonemployees in relation to the remaining total parking spots. Next, employers should multiply that percentage by the employer’s remaining total parking expenses. The resulting amount is the amount the employer may continue to take as a deduction.
Unfortunately, unlike the retroactive allowance for reserved employee spots, there is no parallel provision here allowing employers to reserve spots for nonemployees and take advantage of any retroactive tax benefit.
Step 4: Determine Remaining Use and Allocable Expenses
After completing Steps 1 through 3, the employer should determine if there are any spots that have not been categorized as: (1) reserved for employees, (2) provided primarily for public use, or (3) reserved for nonemployees. If any such spots remain, the employer should use any reasonable method to quantify employee usage of the remaining parking spots and the related parking expenses allocable to those parking spots.
Examples Adapted from Notice 2018-99
Example 1
Employer A incurs $20,000 in total parking expenses per month for the cost of renting 200 parking spots in a parking garage next to Employer A’s office building. On a typical Monday through Friday, 20 non-reserved parking spots are used by Employer A’s employees; 120 parking spots are typically left empty.
Pre-step: Total parking expenses equal $20,000. Total parking spots equal 200.
Step 1: There are no reserved employee spaces. Therefore, there is no amount to be specifically earmarked as a deduction disallowance at this step.
Step 2: The primary use of Employer A’s parking lot is to provide parking to the general public. (180/200=90%). 90 percent of the parking lot – including the 120 parking spots typically left empty – is used by the general public. The “primary use” test is met, because more than 50 percent of actual or estimated usage of the parking spaces in the parking garage is by the general public. Therefore, there is no need to continue with the analysis steps.
Results: The $20,000 in total parking expenses is not subject to the deduction disallowance, and Employer A may continue to deduct the total $20,000.
Tweak: What if Employer A had 20 parking spots reserved for employees only and did not remove the reservation by March 31, 2019? To simplify, assume that the remainder of the parking spaces are used by customers and guests only. Now, 10 percent (20/200) of the parking spots would be reserved for employees only. This means that $2,000 of the total parking expenses would be earmarked as a deduction disallowance ((20/200) x $20,000). The remaining parking spots, however, are provided primarily for usage by the general public. Therefore, Employer A would be permitted to take the remaining $18,000 in total parking expenses as a deduction.
Example 2
Employer C leases 1,000 parking spots for $5,000 in total parking expenses. 50 of the parking spaces are reserved for management, and 800 parking spaces are used by employees.
Pre-step: Total parking expenses equal $5,000. Total parking spots equal 1,000.
Step 1: 50 of the 1,000 spots are reserved for employees. (50/1,000 = 5%). 5 percent multiplied by $5,000 = $250. $250 is earmarked as a deduction disallowance.
Step 2: 800 of the 1,000 spots are used by employees. Thus, provision of parking to the general public is not the primary use of the parking facility.
Step 3: No parking spots are reserved for nonemployees.
Step 4: Employer C may use any reasonable method to determine the remaining use and allocable expenses. The guidance provides that the following reasoning would be reasonable: 84 percent of the remaining parking spots are used by employees (800/the remaining 950 uncategorized spaces), 84 percent of the remaining total parking expense of $4,750 is $3,990 ($5,000 less the $250 earmarked for a deduction disallowance in Step 1). This amount, $3,990, would be earmarked as an additional deduction disallowance.
Result: Employer C’s total deduction disallowance is $4,240 ($250 + $3,990). This suggests that Employer C may take a deduction in the amount of $760 ($5,000 – $4,240).
Example 3
Employer B owns parking garages in two cities in two different states. In City X, Employer B owns two parking garages. The parking expense each month for each parking lot is $10,000. Each has 100 spots. In each, five spaces are reserved for partners and 80 spaces are used by employees.
Employer B’s total parking expenses in City Y total $10,000 for 500 parking spots. None of the parking spaces in City Y are reserved for employees or nonemployees, and 500 parking spots remain empty on a typical business day. (Employer B’s business in City Y is not going well.)
Example 3
Employer B owns parking garages in two cities in two different states. In City X, Employer B owns two parking garages. The parking expense each month for each parking lot is $10,000. Each has 100 spots. In each, five spaces are reserved for partners and 80 spaces are used by employees.
Employer B’s total parking expenses in City Y total $10,000 for $500 parking spots. None of the parking spaces in City Y are reserved for employees or nonemployees, and 500 parking spots remain empty on a typical business day. (Employer B’s business in City Y is not going well.)
Pre-step: Employer B may aggregate all of its parking spaces in each city, but may not aggregate among cities. For simplicity’s sake, then this example will look only at City X. In that city, Employer B’s total parking expenses are $20,000 for 200 parking spots. 10 of those spaces are reserved for partners, and 160 are used by employees.
Step 1: There are no reserved employee spaces. Therefore, there is no amount to be specifically earmarked as a deduction disallowance at this step.
Step 2: 160 of the 200 parking spots are used by employees. Thus, the primary use of the parking facilities is not the provision of parking to the general public.
Step 3: Employer B has 10 parking spots reserved for partners – that is, for nonemployees. 10 reserved nonemployee spots divided by 200 total parking spaces is 5 percent. 5 percent of the total parking expense of $20,000 is $1,000. Thus, $1,000 is earmarked as a deduction allowance.
Step 4: Employer B may use any reasonable method to determine the remaining use and the expenses allocable to employee parking spaces.
Result: Employer B may take a deduction of at least $1,000. Up to $19,000 of the remaining parking expenses may be subject to the deduction disallowance.
This result feels somewhat unsatisfying; however, the guidance is ambiguous in this instance. The text of the guidance provides that, where there are expenses allocable to nonemployee spots, the employer should determine the percentage of such spots in relation to the remaining total parking spots and apply this percentage to the remaining total parking expenses. The guidance does not apply this rule consistently in its examples. This is one of the few disparities that have been observed, and that – hopefully – will be addressed in the final guidance.
Increase in UBTI for Tax-Exempt Organizations
Through largely parallel provisions, the Act disallows a deduction for for-profit entities and creates a corresponding increase in UBTI for tax-exempt organizations. To calculate this, the Act provides a general rule. The UBTI of tax-exempt organizations is increased by any amount: (1) for which a deduction is not allowed under the newly amended Code section 274, and (2) which was paid or incurred by such organization for: (a) any qualified transportation fringe, as defined in Code section 132(f); (b) any parking facility used in connection with qualified parking as defined in Code section 132(f); or (c) any on-premises athletic facility, as defined in Code section 132(j).
There are a few items of note. First, the interim guidance notes that the Act’s provision about on-premises athletic facilities may be essentially disregarded. The portion of the Act that amends Code section 274 does not contain a corresponding provision disallowing an employer’s deduction for on-premises athletic facilities. Therefore, employers may continue to take a deduction for the provision of on-premises athletic facilities that meet the requirements of Code section 132(j).
Second, the rules for calculating any increase in UBTI otherwise intentionally mirror the Act’s changes to Code section 274 regarding the deduction disallowance for for-profit entities. As noted in the interim guidance: When discussing the Act, the Committee on Ways and Means expressly noted that it “believe[d] that aligning the tax treatment for for-profit and tax-exempt employers with respect o nontaxable transportation . . . provided to employees will make the tax system simpler and fairer for all business.” When calculating the increase in UBTI attributable to the provision of qualified parking, tax-exempt organizations should, therefore, follow the same steps as those enumerated for for-profit entities.
Third, the interim guidance clarifies that the provision of a qualified transportation fringe is not itself an unrelated trade or business. therefore, a tax-exempt employer that already has one unrelated trade or business odes not become an organization with more than one unrelated trade or business merely by offering qualified transportation fringes to its employees. Additionally, the “silo rules” of Code section 512(a) do not apply to any increase in UBTI – meaning that a tax-exempt employer with one unrelated trade or business may reduce its UBTI that is traceable to a qualified transportation fringe by any losses sustained by the unrelated trade or business.
Fourth, these changes also impact the filing requirements for tax-exempt organizations. Generally, a tax-exempt organization must now file a Form 990-T if the sum of its gross income from unrelated trades or businesses and its increase in UBTI – including increases attributable to the provision of qualified transportation benefits – is or exceeds $1,000.
What about tax-exempt organizations that provide qualified parking to employees but do not have an unrelated trade or business? The interim guidance is a bit unclear on this point. Its language refers continually to expenses that will result in an “increase” in UBTI. Organizations without an already-existing unrelated trade or business have no existing UBTI to augment. However, an IRS news release accompanying the release of Notice 2018-99 noted that the guidance would “help tax-exempt organizations determine how [ ] nondeductible parking expenses create or increase unrelated business taxable income.” (emphasis added). The IRS should clarify this point when it issues final guidance.
Example
Entity D is a tax-exempt organization. It has one unrelated trade or business, and it owns a parking lot adjacent to its primary office. In a given month, it incurs $20,000 in total parking expenses. The lot has 1,000 parking spaces; 20 parking spots are reserved for employees. During a normal business day, 880 parking spots generally remain empty or are used by clients or guests.
Pre-step: Total parking expenses equal $20,000. Total parking spots equal 1,000.
Step 1: 20 of the 1,000 spots are reserved for employees. (20/1,000 = 2%). 2 percent of $20,000 = $400. Entity D’s UBTI will increase by at least $400.
Step 2: The primary use of the remainder of the parking lot is to provide parking to the general public. (880/(1,000-20) = 90%). Therefore, expenses attributable to these spots are excluded from the deduction disallowance and will not increase Entity D’s UBTI.
Result: Entity D’s UBTI increased by $400. If Entity D does not have gross income from its unrelated trade or business equaling or exceeding $600 so that the total UBTI is less than $1,000, then Entity D does not have to file Form 990-T for that year.
Conclusion
Notice 2018-99 provides interim guidance only. The IRS has requested comments for future guidance to clarify the rules relating to treatment of expenses for the provision of qualified transportation fringe benefits to employees. Until such further guidance is provided, organizations may rely on the provided safe harbor methods for determining the total deduction disallowance or accompanying increase in UBTI.