The IRS has provided interim guidance (Notice 2018-99
) for tax-exempt organizations to determine employee parking expenses that may increase their unrelated business taxable income (UBTI).
The Tax Cuts and Jobs Act (TCJA) added Section 274 to deny employers a deduction for expenses paid or incurred to provide employee parking after Dec. 31, 2017. To create parity between taxable and tax-exempt organizations, the TCJA created the new Section 512(a)(7), which requires tax-exempt organizations to increase their UBTI by the amount of employee parking expenses that would be nondeductible if they were subject to the same deduction disallowance rules as taxable entities. In effect, tax exempt entities now must pay tax of up to 21% on the amount of any disallowed parking expenses.
The TCJA did not change the rules that exclude the value of employer-provided parking (and other qualified transportation fringes) 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 ($260 for 2018 and $265 for 2019, as indexed for inflation).
The notice provides complex and potentially onerous methods for determining nondeductible parking expenses as well as specific guidance and transition relief for tax-exempt organizations, but certain questions remain unanswered. Tax-exempt organizations should begin considering ways to minimize the impact of the new rules on their UBTI.
The interim guidance is discussed in more detail below.
For purposes of Section 512(a)(7), 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. There are a variety of methods employers use to provide tax-free parking benefits to employees. Employers may allow employees to park for free or at a reduced rate in an employer-owned or leased parking facility such a parking lot or garage). Employers may pay a third party so 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. For tax-exempt organizations, the new rules increase the entity’s UBTI by the amount of disallowed parking expenses paid or incurred regardless of the method used by the employer to provide parking benefits. Including these amounts in UBTI essentially subjects them to tax at 21%.
Qualified parking costs
Notice 2018-99 requires employers to determine the “total parking expenses” paid or incurred to provide the parking benefits. The notice explicitly states that the deduction disallowed under Section 274(a)(4) that would increase UBTI relates to the expense of providing parking benefits, not to the value of the parking provided to employees (which is the amount used to determine the amount excluded from the employees’ taxable income under Section 132). The expenses paid or incurred to provide parking benefits to employees 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).
The notice appears to reference a single lease agreement that covers both office space and parking, but does not separately break out the portion of the lease payments attributable to the parking facilities. However, the notice does not provide guidance as to how employers should determine the portion of the lease payments that are treated as parking expenses. Presumably, until further guidance is issued, it would appear that “any reasonable method” could be used to make that determination.
In addition, certain expenses are not subject to the disallowance rules under Section 274(a)(4), and therefore do not increase UBTI:
Methodologies for determining disallowed parking expenses
- Expenses paid or incurred to provide parking to employees who are required to include some or all of the value of the parking benefits in their taxable income under Section 132. This generally occurs to the extent the fair market value of the parking benefits exceeds the monthly limits ($260 for 2018 and $265 for 2019). Unfortunately, the notice does not address how this special rule applies when the fair market value of the benefits exceeds the monthly limit, but the expenses paid or incurred to provide the benefits are less than the fair market value of the benefits.
- Expenses paid or incurred for parking made available to the general public and primarily used by the public. The notice provides guidance on calculating the increase to UBTI in situations where parking is made available to the public but is primarily used by employees.
- Depreciation on a parking structure owned by an organization and used by employees. The depreciation is not taken into account when determining total parking expense that may increase UBTI. In contrast, lease payments paid or incurred for a parking structure owned by a third-party are subject to the new disallowance rules.
- Expenses paid or incurred 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.
The notice provides two methods for calculating the disallowed deduction and increase to UBTI, and their applicability depends on how the parking benefits are provided to the employees. The first method applies to tax-exempt organizations that pay third parties for employee parking spots. The second method applies if the organization owns or leases all or a portion of the parking lot or garage.
First method – payment to a third party for parking spots
Under the first method, which applies to the extent an employer pays third parties for employee parking spots, the deduction disallowance and increase to UBTI is calculated as the organization’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 ($260 in 2018 and $265 in 2019) is included in the employee’s income as compensation, is subject to Form W-2 reporting and employment tax withholding, and is not subject to the disallowance rules under Section 274(a)(4).
Examples of the first method include the following:
Second method – employer-owned or leased facility
- A tax-exempt employer pays a third party operating a parking garage $300 per month for an employee to park in the third-party garage in 2018. A total of $260 of the benefit is excluded from the employee’s income, and the employee recognizes $40 ($300 − $260) of compensation income each month. UBTI is increased by $260 of the monthly cost, but there is no increase to UBTI for the $40 included in the employee’s income.
- An employee elects to pay for parking on a pre-tax basis through a salary deferral program sponsored by the tax-exempt employer. The cost of the employee’s parking is $200 per month. UBTI is increased by 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 second method applies to organizations that own or lease all or a portion of a parking facility. The notice states that the disallowed deduction and the increase to UBTI may be calculated using any reasonable method, and the notice provides a four-step methodology that is deemed to be a reasonable method (essentially a safe harbor method). Although other methods may be used if they are reasonable, any methodology that uses the value of employee parking instead of the expenses paid or incurred will not be considered a reasonable method.
This four-step methodology is as follows:
Step 1: Calculate the disallowance for reserved employee spots
First, determine whether any parking spots in the lot or garage are specifically reserved for the employer’s employees. For example, the parking 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 and increase to UBTI 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, consider a tax-exempt hospital that owns a parking lot with 500 parking spots with a total annual parking expense is $10,000. If 50 of those spots (one-10th) are specifically reserved for the hospital’s medical staff, the employer’s UBTI is increased under this Step 1 by $1,000, one-10th of the total annual parking expenses.
In the notice, the IRS provides a grace period until March 31, 2019, for employers to modify their parking arrangements to reduce or eliminate reserved employee parking spots. Any such changes will be applied retroactively to Jan. 1, 2018, for purposes of Notice 2018-99.
The remaining steps apply to any remaining parking that is 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 will not increase UBTI if the primary use of the remaining parking spots is to provide parking to the general public. The general public includes, but is not limited to, clients, visitors, individuals delivering goods or services to the taxpayer, patients of a health care facility, students of an educational institution, and congregants of a religious organization.
The primary use of the remaining parking spots is treated as being made available to the general public if less than 50% of the actual or estimated usage of the remaining parking spots is by employees during the normal hours of a tax-exempt entity’s activities on a typical day. For this purpose, non-reserved parking spots that are available to the general public, but empty during a tax-exempt organization’s normal hours of activity on a typical day are treated as provided to the general public. If the actual or estimated usage of the parking spots varies significantly between days of the week or times of the year, employers may use any reasonable method to determine the average actual or estimated usage. The percentage is determined by dividing the number of parking spots actually or estimated to be 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).
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 spots for medical staff), 300 spots are estimated to be used by other hospital employees during the normal hours of the hospital’s activities on a typical day. Thus, greater than 50% of the remaining spots are used by employees, so the primary use of the parking lot is not by the general public, and the hospital must increase its UBTI by the costs identified in Step 4 below.
If the primary use of the remaining parking is not for the general public, proceed to Step 3.
Step 3: Calculate the allowance for reserved nonemployee spots
The parking facility, or the employer’s portion of the facility, may reserve parking spots for the exclusive use of nonemployees, such as visitors, customers, patients of a health care facility, students of an educational institution, or congregants of a religious organization. UBTI is not increased for the portion of total parking expenses associated with these reserved nonemployee spots. The portion of the total annual parking expense that does not increase UBTI 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 total annual cost of parking.
Consider the same facts in the Step 1 example, but 45 of the remaining 450 spots are specifically reserved for nonemployees, which is 10% of the remaining parking spots. $1,000 of the $10,000 total annual parking expense will not increase UBTI.
Step 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 and the related expenses allocable to those parking spots. Notice 2018-99 provides general guidelines to follow in determining a reasonable method. The notice states that this reasonable method may take into account the estimated or actual usage of spots by employees based on the number of spots, the number of employees, the hours of use, or other measures.
Increased UBTI for other qualified transportation fringes
New Sections 274(a)(4) and 512(a)(7) apply to qualified transportation fringes other than employee parking expenses, but the notice does not provide guidance for purposes of determining the deduction disallowance for those other fringes. The notice does mention that the IRS intends to publish proposed regulations under Sections 274 and 512, and that those proposed regulations may provide guidance regarding the other qualified transportation fringes. The special UBTI rules for tax-exempt organizations also reference on-premises athletic facilities. Those are addressed in the notice and discussed further below.
Employee parking as part of an unrelated business
Some tax-exempt organizations operate an unrelated trade or business, and the notice provides rules related to qualified parking provided to employees of that unrelated trade or business. The increase to UBTI under Section 512(a)(7) does not apply to the extent the amount for qualified transportation fringes, including qualified parking, paid or incurred is directly connected with an unrelated trade or business that is regularly carried on by the organization. Instead, such expenses for parking (and other qualified transportation fringes) are not deductible pursuant to Section 274(a)(4) when calculating UBTI attributable to the unrelated trade or business.
For example, a tax-exempt organization owns a building in which it sells merchandise to the public, and this building has a small parking lot that can be used only by employees. The business of selling merchandise to the public is an unrelated trade or business of the organization. The total annual expense of the parking lot is not deductible under Section 247(a)(7) when determining the UBTI of the merchandise business instead of an increase to the tax-exempt organization’s UBTI under Section 512(a)(7).
The notice makes it clear that the Section 512(a)(7) increase to UBTI for nondeductible qualified transportation fringes, including parking, is not a separate unrelated trade or business subject to the UBTI silo rules of Section 512(a)(6). This means that a tax-exempt organization with only one unrelated trade or business and an increase to UBTI under Section 512(a)(7) does not become an organization with more than one unrelated trade or business. According to the notice, an organization with only one unrelated trade or business can offset the increase to UBTI under Section 512(a)(7) by the amount which deductions directly connected with the unrelated trade or business exceed the gross income of such unrelated trade or business.
Exception to filing a Form 990-T
- For example, consider a tax-exempt organization that has an unrelated business revenue stream from the sale of the merchandise (described in the example above). This operation is the organization’s only unrelated trade or business. The merchandise operations net income is $1,000. The organization also has expense allocations on the Form 990-T of $100 for state and local taxes and $1,500 for accounting and tax prep fees, resulting in “excess” directly connected deductions of $600 ($1,000 less $100 and $1,500). Additionally, UBTI is increased by $4,000 for the cost of providing employee parking. Under the interim guidance in Notice 2018-99, the organization’s net UBTI is $3,400 (4,000 less $600). This special rule is applicable only for those tax-exempt organizations with just one unrelated business.
Tax-exempt organizations with UBTI less than $1,000, after taking into account the increase to UBTI for parking and other qualified transportation fringe expenses, are not required to file a Form 990-T. This may provide relief to some tax-exempt organizations with a small amount of parking expenses and little or no gross income from unrelated trades or businesses.
There has been some confusion about whether UBTI is increased by the cost of providing on-premises athletic facilities to employees. Section 512(a)(7) states that UBTI is increased by the amount of the deduction disallowed under Section 274 for expenses paid or incurred in providing any on-premises athletic facility. In early drafts of the TCJA, Congress considered an amendment to Section 274 which would disallow all expenses for any on-premises athletic facility. This amendment was not included when the bill was ultimately enacted by Congress. As a result, the pre-TCJA rules under Section 274 with respect to any on-premises athletic facilities still apply. Provided a tax-exempt organization’s on-premises athletic facility is primarily for the benefit of the organization’s employees and does not discriminate in favor of highly compensated employees, a deduction for expenses paid or incurred for the facility is not disallowed under Section 274(a)(4), and there is no increase to UBTI under Section 512(a)(7).
Because of the increase to UBTI for disallowed parking expenses, many tax-exempt organizations that provide parking and other qualified transportation fringe benefits to their employees may owe unrelated business income tax and have to pay estimated income tax for the first time. The IRS issued Notice 2018-100
to provide tax-exempt organizations transition relief for underpayment of estimated income tax. The addition to tax for failure to make estimated income tax payments required to be made on or before Dec. 17, 2018, is waived for tax-exempt organizations that owe unrelated business income tax due to the TCJA changes to parking benefits and other qualified transportation fringes.
Transition relief is available only to tax-exempt organizations that were not required to file a Form 990-T for the taxable year immediately preceding the organization’s first taxable year ending after Dec. 31, 2017. Relief is further limited to tax-exempt organizations that timely file Form 990-T and timely pay the amount reported for the taxable year for which relief is granted.
To claim the waiver of additions to tax, the tax-exempt organization must write “Notice 2018-100” on top of its Form 990-T.
Employers may rely on Notice 2018-99 to determine the amount of nondeductible parking expenses and increases to UBTI until further guidance is issued by the IRS. Tax-exempt entities should re-evaluate their parking arrangements or lease agreements related to parking facilities to avoid or reduce the increase to UBTI for costs related to 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 employer’s exposure to the new rules.
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