8906 / What types of tax-preferred transportation-related fringe benefits can an employer provide to its employees?

An IRS information letter clarified that unused funds that an employee contributed to a qualified transportation plan sponsored by her employer cannot be refunded.  The employee did not use the transportation benefits due to commuting changes brought about by COVID-19.  Unused amounts can be rolled over into subsequent periods, and used for future qualified transportation fringe benefits, as long as the employee's benefits do not exceed the maximum excludable amount for any given month.²  When employees participate in employer-sponsored salary reduction programs, amounts set aside for one type of transportation can be used for a different type of transportation (i.e., funds set aside for public transit can be used for parking expenses).

The rules discussed below generally apply to tax years beginning before 2018 unless otherwise noted. See Q for more information on the calculation of employer-sponsored parking benefits post-tax reform.

The 2017 tax reform legislation also eliminated the ability of taxpayers to exclude qualified bicycle commuting expense reimbursements from gross income and wages from December 31, 2017 to January 1, 2026. However, employers are permitted to provide qualified bicycle commuting benefits and deduct the expenses as ordinary and necessary business expenses.³

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Planning Point: The IRS released guidance providing that employers cannot use a salary reduction plan in order to provide deductible commuting benefits for employees in 2018-2025. As a result of the new rules (discussed above), some employers had considered setting up salary reduction plans in order to deduct the amounts as salary, while the employee could use the funds to pay for parking or transit benefits. The IRS updated Publication 15-B, which now specifically provides that commuting benefits provided through salary reduction, or through a bona fide reimbursement arrangement, are not deductible by the employer.

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Prior to the tax reform legislation’s passage, Congress placed mass transit benefits on par with employer-provided parking expenses, so that a taxpayer could exclude up to $250 a month in employer-provided transportation in a commuter vehicle or employer-provided transit passes. Congress retroactively extended this parity for the 2015 tax year. The Protecting Americans Against Tax Hikes Act of 2015 (PATH) made these provisions “permanent.”

A “qualified transportation fringe” is a benefit provided by an employer to employees, and includes:

(1)  transportation in a commuter highway vehicle that is used in connection with travel between an employee’s home and place of work;

(2)  any transit pass; or

(3)  qualified parking.⁴

A cash reimbursement from an employer to an employee for one of these items also falls within the qualified transportation fringe definition if the transit passes are not readily available in the employer’s area.⁵ A transit pass may still be readily available if the transportation provider only accepts a certain form of payment (i.e., the transportation provider only accepts cash or checks, and the employer has provided a debit card to pay for transit expenses). The IRS has indicated that payment restrictions, unless combined with other restrictions, are not sufficient to cause a transit pass to fail to be readily available.⁶

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Planning Point: The 2017 tax reform legislation created a provision that will cause tax-exempt entities that provide certain employee fringe benefits to become subject to the unrelated business income tax (UBIT, essentially, the corporate tax rate (21 percent) applied to the value of the fringe benefits provided). The UBIT generally applies to income derived from activities that are not substantially related to the tax-exempt purpose of the organization. The UBIT issue will come into play for tax-exempt entities that provide qualified transportation fringe benefits (including transit passes), or access to on-site athletic facilities (i.e., a gym) after December 31, 2017.⁷ As a result, tax-exempt entities that currently provide these fringe benefits should consider restructuring their practices in order to ensure that the UBIT issue is avoided (for example, by increasing employees’ pay to allow them to purchase the benefits). A provision that would have applied the UBIT to certain parking facilities was repealed.

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Self-employed individuals and owner-employees are not considered employees for purposes of qualified transportation fringes.⁸

Code Section 132 places a limit on the amount that may be excluded from income for a qualified transportation fringe. These limitation amounts are adjusted for inflation.⁹

An employee could exclude up to $250 per month in (combined) employer-provided transportation in a commuter vehicle or for transit passes. An employee may exclude $250 per month for qualified parking expenses.¹⁰ The limits are indexed for inflation annually ($325 in 2025, $315 in 2024, $300 in 2023 and $280 in 2022).

For purposes of Section 132, a “commuter highway vehicle” is defined as any highway vehicle that seats at least six persons and which is used at least 80 percent of the time for transporting employees between their homes and places of work.¹¹

A “transit pass” is any pass, token, fare card, voucher or similar item which entitles an individual to transportation on mass transit facilities or in commuter highway vehicles.¹²

“Qualified parking” is defined as parking provided to an employee on or near the employer’s business location or near a location from which an employee commutes to work by mass transit, commuter highway vehicle, or carpool. It does not include any parking near the employer’s place of business that the employee uses for residential parking.¹³

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Planning Point: Some major cities are considering their own commuter benefit laws. For example, it’s expected that Philadelphia employers with 50 or more covered employees will be required to offer a pre-tax payroll deduction for certain mass transit expenses, qualified bicycle expenses or employer-covered benefits for fare instruments beginning December 31, 2022.

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The IRS released a program manager technical assistance providing guidance for employers that chose to make cash reimbursements to employees to compensate them for retroactive increases in the amount of transit benefits that may be excluded from income under IRC Section 132(f). Many employers wished to reimburse employees to account for the increased permissible benefit level in past years. Typically, cash payments made by employers for transit benefits are only excludable from an employee’s income if transit passes are not readily available in the employer’s area. The IRS has indicated that cash amounts that exceed the monthly maximum limit (in any month) will be taxed as wages, even if those amounts are paid because of the retroactive increase in the monthly amount for past years.¹⁴

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Planning Point: An IRS information letter clarified that a taxpayer forfeits any unused transportation benefits upon termination of employment. Because employers are only permitted to provide tax-preferred transportation benefits to current employees, those benefits must be lost once the individual is no longer an employee. This is the case even if the benefits were provided through pre-tax employee contributions, and even if the employee is fired (i.e., compensation reductions cannot be reimbursed if the employee had not fully used them). Importantly, employees can change their elections regarding transportation benefits monthly without the need for a change in status event.¹⁵

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Planning Point: With so many employees working from home for the bulk of 2020, many employees questioned whether they would lose their unused qualified transportation benefits. Some employees opted to drive rather than use public transit--and others did not commute at all. The IRS released an information letter¹⁶ explaining that unused qualified transportation benefit amounts could be rolled over to subsequent periods and used for future commuting expenses. To qualify, the employee must have made a valid compensation reduction election and remain employed by the employer in the subsequent period. Further, the IRS confirmed that unused amounts could be applied to other types of qualified transportation benefits, including parking, if the employer offers that benefit. On the other hand, the IRS noted that refunds of unused qualified transportation benefits are not permitted if those benefits are provided through a compensation reduction agreement. Employers may wish to revisit the terms of their transportation benefit plan to ensure employees can take advantage of this flexibility.

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