The IRS Finalizes Regulations On Qualified Transportation Fringe Benefits

The IRS has finalized proposed regulations pertaining to employer-provided transportation arrangements under Internal Revenue Code Section 132(f). For the most part, the final regulations adopted proposed qualified transportation regulations which were issued on January 27, 2000.

Code Section 132(f) provides that an employee can exclude qualified transportation fringe benefits from wages and employment taxes up to certain limits. Qualified transportation benefits include qualified parking expenses (up to $180 per month), transit passes (up to $65 per month), and transportation in commuter highway vehicles (up to $65 per month). Beginning January 1, 2002, the limits for transit passes and commuter highway vehicle expenses will be increased to $100 per month.

The value of transportation in a commuter highway vehicle, transit passes, and qualified parking is calculated on a monthly basis to determine whether the value of the benefit has exceeded the applicable statutory monthly limit on qualified transportation fringes. In the case of transportation in a commuter highway vehicle or qualified parking, the applicable statutory monthly limit applies to qualified transportation fringes used by the employee in a month. In the case of a transit pass, the applicable statutory monthly limit applies to the transit passes provided by the employer to the employee in a month for that month or for any previous month in the calendar year.

Because the finalized regulations are not extensive, they provide an excellent opportunity for employers to provide a useful benefit to employees with little expense or complexity. The final regulations were issued in a question and answer format and make the following clarifications:

1. Qualified Parking Expenses

Qualified parking is parking which is provided to an employee and is on or near the business premises of the employer, or at a location from which the employee commutes to work by carpool, commuter highway vehicle, mass transit facilities, transportation provided by any person in the business of transporting persons for compensation or hire, or by any other means if:

(1) The employer pays for the parking;

(2) The employer reimburses the employee for the parking expenses; or

(3) The parking is on property that the employer owns or leases.

• The final regulations clarify what is considered qualified parking. Qualified parking does not include reimbursement for parking that otherwise is excludable from an employee's income as a reimbursement under an "accountable plan" under 1.62-2 or parking provided in kind that is excludable from income as a "working condition fringe." This means that if another income exclusion is available for parking expenses, Section 132(f) is not available.
• As with the proposed regulations, the final regulations require that an employee who receives a cash reimbursement for qualified transportation expenses must provide documentation to the employer that the funds were used for a qualified transportation expense. In general the employer must institute "reasonable procedures" to ensure that an expense was incurred. A statement by the employee that the expenses were used for qualified transportation expenses generally will suffice, or the employee can provide a receipt. The regulations state to be reasonable the documentation must be received within 180 days after the expense was incurred.
• Many employers provide a program under which employees can choose between current cash compensation and qualified transportation fringe benefits. The final regulations adopt the requirement in the proposed regulation that the employer keep appropriate written records of employees' salary reduction elections. Salary reductions may be made in writing or electronically and can be renewed automatically. In addition, employers can provide for deemed salary reduction elections if the employee does not elect to receive cash compensation if the employee is given notice that a reduction will be made.

2. Transit Passes And Commuter Vanpools

A Transit Pass is any pass, token, farecard, voucher or similar item entitling a person to transportation on a mass transit facility (whether publicly owned or not) or transportation provided by any person in the business of transporting persons for compensation or hire if provided in a highway vehicle with a seating capacity of at least six adults.

• The employer can only reimburse an employee for the cost of transit passes if vouchers or similar items that can be exchanged for transit passes are not readily available to the employer. The final regulations clarify that a voucher is "readily available" if the employer can obtain it on terms no less favorable than those available to an individual employee and without incurring a significant administrative cost. The determination is made with respect to each transit system voucher. If the administrative costs relating to fees paid to the transit providers and not internal administrative costs incurred by the employer are more than 1% (disregarding delivery charges not in excess of $15 per order) of the average monthly value of the vouchers for a transit system, it is significant. The IRS has allowed employers until plan years beginning after December 31, 2003, to comply with this 1% safe harbor.
• If multiple transit system vouchers are available for direct distribution to employees, the employer must consider the lowest cost voucher for purposes of determining whether the voucher provider fees cause vouchers to exceed the 1% limit and not be readily available. If multiple vouchers are required in an area to meet the transit needs of the individual employees in that area, the employer may average the costs applied to vouchers from each system for purposes of determining whether the voucher provider fees cause vouchers to not be readily available.
• The final regulations also provide guidance on the types of nonfinancial restrictions that make vouchers not readily available. Certain nonfinancial factors such as a voucher provider not making vouchers available for purchase at reasonable intervals or failing to provide the vouchers within a reasonable period after receiving payment can cause the vouchers to not be readily available. In addition, if the voucher provider does not provide vouchers in reasonably appropriate quantities or denominations they may not be readily available.
• The final regulations permit transit passes to be distributed in advance for more than one month by taking into account the monthly limits for all months for which the passes are distributed. For example, a three month pass worth $190 is excluded from income and employment taxes because $190 does not exceed $195 (the $65 monthly limit multiplied by three months). If an employee who has received a pass in advance terminates employment before the beginning of the last month in period covered by the pass, the value of the last month's pass is excluded from wages for employment tax purposes but not for income tax purposes unless at the time the passes were distributed there was an established termination date that was before the beginning of the last month of that period.
• There are no substantiation requirements if the employer distributes transit passes in kind. The employer can distribute a voucher in-kind by having a third party, such as the transit operator, distribute the voucher.
• The final regulations make no relevant changes with respect to commuter highway vehicles.

The final regulations are generally applicable for taxable years beginning after December 31, 2001 (except the 1% safe harbor, which has a later effective date, as described above). Taxpayers may rely on the new final regulations, however, until the regulations are effective, the standards in IRS Notice 94-3 also continue to apply.

ACTION NEEDED: If you want to take advantage of the tax savings permitted under the new regulations, you should review any transportation fringe benefits that you currently offer to determine if they meet the qualified transportation fringe benefit requirements. A Davis Wright Tremaine LLP employee benefits attorney can assist you in determining how to take advantage of the favorable new rules relating to qualified transportation fringe benefits.