Proposed regs clarify nondeductible QTFs, parking

The IRS’s proposed regulations (REG-119307-19) on the elimination of deductions for employee parking and other qualified transportation fringe (QTF) benefits offer new simplified methods and exceptions, but the rules are still complex in many areas. The proposed regulations also address the nondeductible expenses associated with providing transportation to an employee between the employee’s residence and place of work.

Under new Section 274(a)(4), enacted by the Tax Cuts and Jobs Act (TCJA), expenses paid or incurred by employers after Dec. 31, 2017, to provide QTF benefits generally are no longer deductible. The TCJA also added Section 274(l), which disallows an employer’s deduction for the expense of providing transportation between an employee’s residence and place of employment. The TCJA did not change the rules that exclude the value of employer-provided parking and other QTFs from the employees’ taxable income. Section 132 continues to exclude the value of these benefits from an employee’s income to the extent the value does not exceed a monthly threshold ($265 for 2019 and $270 for 2020, as indexed for inflation). The TCJA also originally required tax-exempts to pay tax on the nondeductible expenses, but this change was recently repealed retroactive to its enactment.

The proposed regulations retain most of the interim guidance on determining nondeductible parking expenses issued through Notice 2018-99 in December 2018, but introduce some key changes:

• For purposes of an exception to the deduction disallowance, the proposed guidance would expand the definition of “general public” for multi-tenant buildings and parking facilities to treat individuals associated with unrelated tenants as the general public.
• For employers that pay one amount to lease a building with access to a parking facility, the proposed guidance would provide a safe harbor that allows employers to allocate 5% of the total lease and other costs to parking expense.
• The proposed regulations would allow employers to use statistical sampling (following the procedures of Rev. Proc. 2011-42) to determine employee usage of parking spaces when using certain methods to determine the nondeductible amount.
• The proposed regulations would introduce two new methods to determine the amount of nondeductible parking expense.
• The proposed regulations would define the term “geographic location” narrowly, which would limit an employer’s ability to aggregate parking facilities when determining the amount of nondeductible expenses.
• The proposed regulations include a de minimis exception to the deduction disallowance when employers have a limited number of parking spots reserved exclusively for employees.

In addition to employee parking expenses, the proposed regulations address the nondeductible expenses for other QTFs, including transit passes and commuter highway vehicles, which were not addressed in Notice 2018-99.

The proposed regulations are also the IRS’s first set of guidance under Section 274(I). The disallowed deduction under Section 274(l) is separate from and in addition to the Section 274(a)(4) rules that disallow a deduction for QTFs. Section 274(l) applies to the transportation expenses that are not a QTF, such as a car service or flight between the employee’s residence and place of employment. The new Section 274(l) rules may have gone unnoticed by some employers, so employers should consider whether they have a disallowed deduction for this type of transportation.

Considering these proposed regulations, employers should re-evaluate their previous positions determining the extent to which their QTF expenses are nondeductible, especially considering the expanded exceptions to the disallowance and new simplified methods. Although the regulations are not proposed to apply until tax years beginning on or after the date final regulations are published, employers may rely on them or the guidance in Notice 2018-99 until the proposed regulations are finalized. In addition, employers should determine whether Section 274(l) may disallow deductions for other transportation expenses.

Qualified transportation fringes Section 274(a)(4) and the proposed regulations apply to employer expenses for providing the various forms of QTF benefits to an employee. QTFs include employee parking, transit passes and transportation in a commuter highway vehicle. For this purpose, an employee includes a common law employee or statutory employee, such as an officer of a corporation, who is currently employed by the employer. The definition of employee does not include a partner, 2% shareholder of an S corporation, sole proprietor, director or independent contractor. Expenses incurred to provide QTFs to nonemployees remain deductible.

For purposes of these proposed rules, employee parking includes 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. The rules cover a variety of ways employers use to provide tax-free parking and other QTFs to employees. Employers may allow employees to park for free or at a reduced rate in an employer-owned or leased parking facility (for example, a parking lot or garage). Employers may pay a third party so the employer’s employees can park at the third party’s garage or lot. Alternatively, employers may reimburse employees for the cost of parking or allow employees to pay for parking on a pre-tax basis through a salary reduction arrangement. The new rules disallow an employer’s deduction for expenses paid or incurred regardless of the method used by the employer to provide parking benefits.

A transit pass is any pass, token, farecard or similar item that entitles a person to transportation on mass transit facilities. For example, a transit pass includes a subway or bus pass.

A commuter highway vehicle is a highway vehicle with a seating capacity of at least six adults (excluding the driver) and with respect to which at least 80% of the vehicle’s mileage for a year is reasonably expected to be 1) for transporting employees in connection with travel between their residences and place of employment, and 2) on trips during which the number of employees transported for commuting is at least 50% of the adult seating capacity of the vehicle (excluding the driver). The QTF is the employer-provided transportation on the commuter highway vehicle. For example, an employer may own or lease a shuttle van that picks up employees at their residences and drops them off at work. This may be a QTF.

Similar to qualified parking, a transit pass and transportation on a commuter highway vehicle can be provided in a variety of methods, including in-kind benefits, employer-paid, reimbursement or through pre-tax salary reductions.

Qualified parking expense The proposed regulations retain the guidance in Notice 2018-99 that requires employers to determine the “total parking expenses” paid or incurred to provide qualified parking. The deduction disallowed under Section 274(a)(4) relates to the expense of providing parking benefits, and not to the value of the parking provided to employees (value is used to determine the amount excluded from the employees’ taxable income under Section 132). Total parking expense means all expenses of the employer related to providing parking spaces in a parking facility, which include, but are not limited to, repairs, maintenance, utilities, insurance, property tax, interest, snow removal, leaf or trash removal, cleaning, landscaping, parking attendant expenses, security, and rent or lease payments or a portion of rent and lease payments (if not separately broken out).

Mixed parking expenses Employers that lease or own a parking facility may pay a single expense that includes both parking facility and non-parking facility expenses. These expenses are referred to as “mixed parking expenses” in the proposed regulations. One of the most common mixed parking expenses is a lease payment for a building and parking facility where the lease does not separately state an amount for the parking facility. The proposed regulations do not provide a methodology for determining the amount of the mixed parking expense that should be allocated to the total parking cost, but instead provide that an employer may use any reasonable method to allocate a portion of the expense to parking.

However, the proposed regulations provide a 5% safe harbor that may be applied under certain prescribed methods (detailed below) for determining nondeductible parking expenses. Under the safe harbor, an employer may choose to allocate 5% of certain mixed parking expenses to a parking facility. Mixed parking expenses eligible for the safe harbor include lease or rent expenses, property taxes, interest expense and expenses for insurance and utilities.

Exempt expenses and exceptions Certain expenses are not subject to the disallowance rules under Section 274(a)(4), and otherwise may be deductible:

Nonemployee expenses Expenses paid or incurred by businesses to provide parking to partners of a partnership, 2% shareholders of S corporations, a sole proprietor and independent contractors generally are deductible because such individuals are not permitted to exclude the value of parking and other QTFs from income under Section 132.

Amounts included in compensation A QTF expense is exempt from the disallowance to the extent the QTF is treated as compensation to the employee on the employer’s tax return and as wages to the employee. This generally occurs to the extent the fair market value of the monthly parking benefit (or other QTF) exceeds the monthly limits for excluding the QTF from income ($265 for 2019 and $270 for 2020). For example, in 2020 an employer pays a third party $300 a month so an employee can park in a garage. The value of the qualified parking is also $300. The employee is required to recognize $30 of compensation, so the employer can deduct $30 of the parking expense (the remaining $270 of the parking expense is nondeductible).

This exemption applies only to the extent both of the following conditions are met:

• The employer treats the amount includible in the employee’s income as compensation on the employer’s original U.S. federal income tax return for the taxable year in which the benefit is provided to the employee. Presumably, this means that employers cannot amend previously filed income tax returns to treat this as compensation and claim the deduction.
• The excess value is treated as wages subject to U.S. federal income tax withholding.

The exception for amounts included in compensation applies only to the extent the value of the QTF is in excess of the monthly limits plus any amount paid by the employee with after-tax money. This exception does not apply if the value that is included in the employee’s income as compensation is less than the amount required to be included in income or if the purported amount required to be included in income is $0.

Expenses for items available to the general public Any expense paid or incurred by an employer for a QTF made available to the general public is not disallowed. This exception to Section 274(a) will primarily apply to parking provided by employers to employees.

If the primary use of the parking facility is to provide parking to the general public, the entire amount of the parking expense is not subject to the disallowance except expenses specifically attributable to employee parking (e.g., expenses allocated to reserved employee parking spots). A parking facility is primarily used by the general public if more than 50% of the actual or estimated use of the available parking spaces is treated as used by the general public.

If the primary use of the parking facility is not by the general public, this exception applies only to the expenses allocable to the parking used by the general public. The general public includes, but is not limited to, customers, clients, visitors, individuals delivering goods or services, students of an educational system and patients at a healthcare system. The general public does not include individuals who are employees, partners, 2% shareholders of S corporations, sole proprietors, or independent contractors of the employer. An exclusive list of guests is also not the general public.

The proposed regulations provide an important expansion of the definition of general public for employers that own or lease parking spaces in a multi-tenant building. Under the proposed definition, the general public would include employees, partners, 2% shareholders of S corporations, sole proprietors, independent contractors, clients, or customers of unrelated tenants in the building. The proposed regulations do not define the term “unrelated.”

Depreciation An employer’s total cost of parking does not include the depreciation on a parking structure owned by the employer and used by employees. The IRS takes the position that depreciation is an allowance for the exhaustion, wear and tear of property and is not an expense.

The exception for depreciation also applies to commuter highway vehicles owned by an employer.

Items near the parking facility Total parking expense does not include expenses for items not located on or in the parking facility. This may include landscaping and lighting adjacent to the parking structure and walkways between the parking structure and office building.

Items sold to customers Expenses paid or incurred by an employer for QTFs are not subject to the disallowance to the extent a QTF is sold to customers in a bona fide transaction for adequate and full consideration. Customers include an employee of the employer who purchases the QTF in a bona fide transaction. As a result, if an employer provides parking to employees but requires the employees to pay full consideration for the parking in a bona fide transaction, the parking expenses are not subject to the disallowance.

Key definitions The proposed regulations define certain terms that are used in the proposed methods for determining the disallowed QTF expense, including the following:

Parking facility A parking facility includes indoor and outdoor garages and other structures, as well as parking lots and other areas, where an employer provides qualified parking to one or more of its employees. It does not include parking spaces on or near property used by an employee for residential purposes.

Geographic location Parking facilities that are in a single geographic location can be aggregated when determining the disallowed parking expense. The proposed regulations define “geographic location” as contiguous tracts or parcels of land owned or leased by the employer. Two or more tracts or parcels of land are contiguous if they share common boundaries (or would but for the interposition of a road, street, railroad, stream or similar property). However, tracts or parcels of land which touch only at a common corner are not considered contiguous for this purpose.

Inventory/unusable spaces This includes parking spaces used for inventoried vehicles, qualified nonpersonal use vehicles (as described in Treas. Reg. Sec. 1.274-5(k)), other fleet vehicles used in a taxpayer’s trade or business, or spaces otherwise not usable for parking by employees. Examples of such parking spaces include, but are not limited to, parking spaces for vehicles that are intended to be sold or leased at a car dealership or car rental agency, parking spaces for vehicles owned by an electric utility used exclusively to maintain electric power lines, or parking spaces occupied by trash dumpsters (or similar property). Some examples of qualified nonpersonal use vehicles include clearly marked police vehicles, ambulances, dump trucks and forklifts.

Inventory/unusable spaces are specifically excluded from the definitions of “available parking spaces” and “reserved nonemployee spaces” under the primary use method and primary use test (discussed below) because those spaces are generally not available to employees or the general public but are instead used for other purposes. However, inventory/unusable spaces are included in total parking spaces under the cost per space method (discussed below).

Reserved employee spaces Reserved employee spaces are parking spaces that are exclusively reserved for employees, but do not include inventory/unusable spaces.

Available parking spaces This is the number of total parking spaces, less reserved employee spaces and inventory/unusable spaces, that are available to employees and the general public.

Peak demand period This is the period of time on a typical business day when the greatest number of the employer’s employees are using parking spaces in the facility. If an employer’s employees work in shifts, the peak demand period would take into account the shift during which the largest number of employees park in the employer’s parking facility. However, a brief transition period during which two shifts overlap in their use of parking spaces, as one shift of employees is getting ready to leave and the next shift is reporting to work, may be disregarded.

Payments to a third party for parking spots The proposed regulations provide two sets of methods for calculating the disallowed deduction. The first applies to the extent an employer pays a third party for qualified parking. Under this method, the deduction disallowance is calculated as the employer’s total annual cost of employee parking paid to the third party. Any amount paid in excess of the monthly qualified parking exclusion under Section 132 ($265 for 2019 and $270 for 2020) is not subject to the disallowance if the exception for amounts included in the employee’s income (discussed above) applies.

Examples of this method include the following:

• An employer pays a third party operating a parking garage $300 per month for an employee to park in the third-party garage in 2020. $270 of the monthly benefit is excluded from the employee’s income, and the employee recognizes $30 ($300 minus $270) of compensation income each month. The employer is not allowed a deduction for $270 of the monthly cost but is allowed a deduction for the $30 included in the employee’s wages subject to U.S. federal income tax withholding.
• An employee elects to pay for parking on a pre-tax basis through a salary reduction program sponsored by the employer. The cost of the employee’s parking is $200 per month. The employer is not allowed a deduction for the full $200 per month that is used to pay for the parking, even though parking is paid with the employee’s pre-tax salary. The same treatment would apply if the employer reimbursed the employee for the $200 per month of parking expenses -– the $200 reimbursement would not be deductible.

Employer-owned or leased facility The second set of methods applies when the employer leases or owns all or a portion of the parking facility. The proposed regulations state that the disallowed deduction may be calculated using any reasonable method and provide a general rule and three “simplified” methods that are deemed to be reasonable methods (essentially safe harbor methods). Employers may choose to use the general rule or any of the simplified methods for each taxable year and for each parking facility.

General rule Under the general rule, employers can calculate the deduction disallowance for each employee receiving qualified parking based on a reasonable interpretation of Section 274(a)(4), as long as an employer’s methodology does not use the value of a QTF instead of its expense, fail to allocate parking expenses 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).

Unfortunately, employers using the general rule may not use the 5% safe harbor for mixed parking expenses. This means an employer using the general rule cannot allocate 5% of a lease cost to parking expense. However, users of the general rule can aggregate parking in a single geographic location when determining the amount of the disallowance.

The following are the “simplified” methods included in the proposed regulations.

Qualified parking limit method Under the qualified parking limit method, an employer must calculate the nondeductible parking expense in each month of a taxable year by multiplying the monthly qualified parking exclusion limit under Section 132(f)(2) ($265 in 2019 and $270 in 2020) by either 1) the total number of spaces used by employees during the peak demand period, or 2) the total number of the employer’s employees.

This method may be used only if the employer includes in the employee’s compensation income the value of the qualified parking in excess of the sum of 1) the amount, if any, paid by the employee for the parking and 2) the monthly qualified parking exclusion limit. The excess value must be reported on the employer’s originally filed U.S. federal income tax return as compensation paid to the employee and treated as wages to the employee for purposes of U.S. federal income tax withholding.

For example, an employer has a parking lot with 100 spots and determines that employees use 80 of those spots during the peak demand period. The monthly nondeductible amount under this method is $21,600 (80 spots at $270 each).

The exception to the deduction disallowance for amounts treated as employee compensation cannot be applied to reduce the deduction disallowance calculated under this method. Furthermore, an employer using this method may not use either the 5% safe harbor for mixed parking expenses or the aggregation option for parking facilities in a single geographic location.

Primary use method The primary use method generally follows the four-step process introduced in Notice 2018-99 to determine nondeductible parking expenses. Employers may use either or both the 5% safe harbor for mixed parking expenses and the aggregation option for parking facilities in a single geographic location. The four steps are described separately below:

Step 1: Calculate the disallowance for reserved employee spots
First, determine whether any parking spots in the facility are specifically reserved for the employer’s employees. The reserved employee spots may be designated by signage or through the use of a separate facility or portion of the facility segregated by a gate that limits access. The amount of the deduction disallowed under this step is determined by multiplying the total parking expenses for the facility by a percentage equal to the total number of reserved employee spots divided by the total number of parking spots in the parking facility.

For example, an employer owns a parking lot with 500 parking spots, and the total annual parking expense is $10,000. Fifty of those spots are specifically reserved for the employer’s management team. The employer is not allowed a deduction under Step 1 for $1,000 of the total annual parking expenses ($10,000 times the product of 50 divided by 500).

The proposed regulations provide an exception when an employer has a limited number of reserved employee spots. The deduction for reserved employee spots will not be disallowed if the following conditions are met:

1. The primary use of the available parking spaces is to provide parking to the general public (as determined by the “primary use test” described below in Step 2),
2. There are five or fewer reserved employee spots in the parking facility, and
3. Reserved employee spaces make up 5% or less of the total parking spaces.

If all the parking spots in a facility are reserved employee spots, then the total parking expense is not deductible. The remaining steps apply to any parking spots that are not specifically reserved for the employer’s employees.

Step 2: Determine the primary use of remaining spots (the “primary use test”)
The remaining parking facility costs are fully deductible if the primary use of the remaining parking spots is to provide parking to the general public. The term “primary use” means greater than 50% of the actual or estimated usage of the remaining parking spots in the parking facility. The percentage is determined by dividing the number of parking spots used by employees (excluding reserved employee spots identified in Step 1) by the total number of remaining parking spots in the facility (excluding reserved employee spots identified in Step 1).

Employers may use any reasonable methodology to determine the number of spaces used by employees during the peak demand period on a typical business day. A reasonable methodology may include periodic inspections or employee surveys.

Non-reserved parking spots that are available to the general public, but empty during normal business hours on a typical business day are treated as provided to the general public.

As discussed above, the general public includes employees, partners, 2% shareholders of S corporations, sole proprietors, independent contractors, clients, or customers of unrelated tenants in a multi-tenant building owned or leased by the employer.

Consider the same facts as the example in Step 1. The parking lot is generally available to the public. Of the remaining 450 parking spots (excluding the 50 reserved employee spots), 300 spots are estimated to be used by employees during normal business hours on a typical business day. Thus, 50% or greater of the remaining spots are used by the employer’s employees, so the primary use of the parking lot is not by the general public.

Alternatively, consider an employer that leases one floor of a five-floor multi-tenant building and receives access to parking in a 500-space lot as part of the lease without any reserved employee spots. During normal business hours on a typical business day, the employer’s employees use 50 of the spots and the remaining spots are used by the employer’s customers and visitors and the employees, customers and visitors of the other unrelated tenants in the building. Because the individuals parking in the lot other than the employer’s employees are treated as the general public, 90% of the parking is treated as used by the general public and the primary use of the parking is by the general public. In this example, none of the total parking expense is disallowed as a deduction under Section 274(a)(4).

If the primary use of the remaining parking is not for the general public, Step 3 should be used.

Step 3: Calculate the allowance for reserved nonemployee spots
Employers may deduct the portion of total parking expenses allocated to any reserved nonemployee spots. Reserved nonemployee spaces are spaces specifically reserved for nonemployees, including spaces reserved for visitors, customers, partners, 2% shareholders of an S corporation, vendors and passenger loading and unloading. The deductible portion of the total parking expense is determined by dividing the number of reserved nonemployee spots by the total remaining parking spots (excluding reserved employee spots identified in Step 1) and multiplying the percentage by the remaining total parking expense.

Consider the same facts in the Step 1 example. Forty-five of the remaining 450 spots (or 10%) are specifically reserved for nonemployees. Thus $900 (10% of the $9,000 remaining parking expense) of the $10,000 total annual parking expense is deductible and not subject to Section 274(a)(4) under this Step 3.

4: Determine remaining use and allocable expenses
If any of the total annual parking expense amount remains after completing Steps 1-3, employers must use a reasonable method to determine the employee use of the remaining parking spots during the peak demand period and the related expenses allocable to those parking spots.

Cost-per-space method Under the cost-per-space method, an employer must calculate the nondeductible parking expenses by multiplying the cost per space by the total number of available parking spaces used by employees during the peak demand period. An employer may calculate cost per space by dividing total parking expenses by total parking spaces. Employers using this method may use either or both the 5% safe harbor for mixed parking expenses and the aggregation option for parking facilities in a single geographic location.

Deduction disallowance for transit passes and commuter highway vehicles The Section 274(a)(4) deduction disallowance applies to QTFs other than employee parking expenses, which include transportation provided to employees via a commuter highway vehicle between the employee’s residence and place of employment and any transit pass provided to employees. The proposed regulations provide additional guidance for purposes of determining the deduction disallowance for these other fringes. Specifically, if a taxpayer pays a third party an amount for its employees’ transportation in a commuter highway vehicle or a transit pass, the deduction disallowance generally is equal to the taxpayer’s total annual cost paid to the third party.

If a taxpayer provides transportation in a commuter highway vehicle or a transit pass in-kind directly to its employees, the taxpayer must calculate the deduction disallowance of the expenses for such fringes based on a reasonable interpretation of Section 274(a)(4). However, a taxpayer may not use the value of the qualified commuter highway vehicle or transit pass fringe provided to the employee to determine expenses allocable to such fringe. If an employer reimburses an employee or allows an employee to use pre-tax dollars to pay for a transit pass or transportation in a commuter highway vehicle, the employer’s disallowed deduction is equal to the reimbursement or amount paid by the employee with pre-tax dollars.

Transportation and commuting benefits The proposed regulations would also include Prop. Treas. Reg. Sec. 1.274-14, which addresses the new deduction disallowance under Section 274(l). Under Section 274(l), 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. Travel between the employee’s residence and place of employment includes travel that originates at a transportation hub near the employee’s residence or place of employment.

For this purpose, an employee’s residence is defined in Treas. Reg. Sec. 1.121-1(b)(1), which is a “facts and circumstances” test. According to these regulations, an employee’s residence may include a houseboat or a house trailer.

The following are two examples of transportation expenses that are not deductible under the general Section 274(l) rule:

• An employee of a company resides in Miami but works in New York City. Each Monday the employee flies from Miami to New York City, and each Friday the employee takes a return flight to Miami. The company pays the expense for these flights. The expense paid by the company is not deductible because the flight is transportation between the employee’s residence in Miami and place of employment in New York City. In addition, any expense associated with transportation between the employee’s residence or hotel and the applicable airport is not deductible to the extent paid by the employer.
• An employee works and resides in Chicago. Each morning a car service drives the employee from her residence to her office and then drives the employee home in the evening. The employee’s employer reimburses the employee for the cost incurred for the car service. Under the general rule, the employer is not allowed a deduction for the amount reimbursed to the employee for the car service.

Exception to Section 274(l) The preamble to the proposed regulations clarifies that the transportation expense disallowance under Section 274(l) applies regardless of whether the employee recognizes any compensation income related to the transportation. Accordingly, the expense of providing transportation between an employee’s residence and place of employment is generally disallowed as a deduction even if the employee includes the value of that transportation in gross income.

There is a single exception to this deduction disallowance. The deduction disallowance does not apply if the transportation or commuting expense is necessary for ensuring the safety of the employee. The proposed regulations provide that the transportation or commuting expense is considered necessary for ensuring the safety of the employee if a bona fide business-oriented security concern (as described in Treas. Reg. Sec. 1.132-5(m)) exists for the employee.

Applicability date The proposed regulations are proposed to apply for taxable years beginning on or after the date final regulations are published. In the interim, employers may rely on these proposed regulations when determining the amount of expense that is not deductible pursuant to Sections 274(a)(4) and 274(l). Alternatively, employers may choose to rely on the guidance in Notice 2018-99 until these proposed regulations are finalized.

Next steps Companies should re-evaluate their parking arrangements or lease agreements related to parking facilities to mitigate or reduce the deduction disallowance for reserved employee parking spots. Employers should also quantify their total parking expenses and consider opportunities to reduce those expenses. In addition, employers should consider whether there are any other reasonable methods for determining the nondeductible portion of parking expenses, which may reduce the amount of nondeductible expenses under the new rules.

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