Internal Revenue Service guidance on non-deductible transportation benefits
Article

Internal Revenue Service guidance on non-deductible transportation benefits

The Internal Revenue Service (IRS) recently released Notice 2018-99, which provides guidance on non-deductible transportation benefits. While the Notice touches on other aspects of IRC section 274(a)(4), which generally disallows a deduction for expenses associated with qualified transportation fringes (QTF), this tax alert will focus on qualified parking, which has the most far-reaching consequences for tax-exempt organizations.

The Tax Cuts and Jobs Act (TCJA) stipulated under the new IRC section 512(a)(7) that an organization’s unrelated business taxable income (UBTI) would be increased by the amount of QTF expenses that are now nondeductible under section 274. For most organizations, that means parking. Any organization which provides parking to its employees, whether by paying a third party on its employees’ behalf or by providing employees with parking on its own, may be impacted by this new rule.

When calculating the amount to report as UBTI, there are different methods used by organizations that pay a third party and organizations that incur costs associated with their own lots and garages. For organizations that pay a third party for parking for their employees, generally the whole amount is non-deductible under section 274. However, the monthly limitation on exclusion from income for employees’ QTF under section 132(f)(2), $260 for 2018, limits the amount of UBTI that the organization has to report. Any amount per employee per month that exceeds $260 must be treated as compensation to the employee and reported on the employee’s W-2.

Example 1:

Organization A pays a third-party garage $100 per month for each of A's 10 employees, or $12,000 per year (($100 x 10) x 12 = $12,000). The entire $12,000 will need to be reported as UBTI.

Example 2:

Organization A pays a third-party garage $300 per month for each of A’s 10 employees, or $36,000 per year (($300 x 10) x 12 = $36,000). Of the $300 per month paid for each employee, $260 is considered excludible from an employee’s compensation. Thus, $31,200 (($260 x 10) x 12 = $31,200) will need to be reported as UBTI. The extra $40 per employee per month will need to be treated as compensation to the employees. Therefore, $4,800 ($40 x 10 x 12) is treated as compensation expense.

Calculation of Amount Subject to Tax:

For organizations that own or lease all or a portion of one or more parking facilities where its employees park, the § 274(a)(4) disallowance may be calculated using any reasonable method. Using the value of employee parking to determine expenses allocable to employee parking in a parking facility owned or leased by the taxpayer is not a reasonable method.

A “parking facility” is any indoor or outdoor garage or other structure, as well as parking lots and other areas where employees may park, that is on or near the business premises or near a location where the employee can commute to work. This includes parking lots or garages either owned or leased by organizations. This does not include residential parking. The organization may aggregate the number of spots from multiple lots in the same location but may not aggregate parking spots from different locations.

Expenses that may be included are, but are not exclusive to, repairs, maintenance, utility costs, insurance, property taxes, interest, snow and ice removal, leaf removal, trash removal, cleaning, landscape costs, parking lot attendant expenses, security and rent or lease payments. Depreciation is not considered a parking expense for purposes of this notice. Expenses paid for items not located on or in the parking facility, including items related to property next to the parking facility, such as landscaping or lighting, are not included.  Note that if an organization has a lease for which the parking is not separately stated, an allocation must be done to calculate the portion of the lease dedicated to the parking spots.

The Notice provided a four-step process that can be relied upon as a safe harbor method to determine the number of parking spot expenses that must be included in UBTI.

  • Step 1: Calculate the disallowance for reserved employee spots

    If any parking sports are reserved for the organization’s employees, whether by signage or physical barriers (chains, card access) these are automatically included in the UBTI calculation.  Organizations have until March 31, 2019 to change their parking arrangements to decrease or eliminate their reserved spots. This relief is retroactive to Jan. 1, 2018.
  • Step 2:  Determine the primary use of the remaining spots (the “primary use” test)

    Organizations then identify the remaining parking sports to determine whether their primary use is for the public. If the primary use of the remaining spots is for the general public, then the remaining total parking expenses are excepted from UBTI reporting. “Primary use” is quantified as more than 50 percent of actual or estimated use. Testing must be done during normal business hours on a typical day, or during the normal hours of an exempt organization on a typical day. If days/times of the year vary widely, the organization can use any reasonable method to determine estimated usage.
  • Step 3:  Calculate the allowance for reserved nonemployee spots

    If the primary use of the remaining parking spots is not for the general public, then the organization should identify the number of spots that are reserved exclusively for nonemployees.  Spots may be reserved by signage or physical barriers to entry. If the organization has reserved nonemployee sports, it may determine the percentage of nonemployee reserved spots in relation to the remaining spots and multiply that by the organization’s remaining parking spots.
  • Step 4:  Determine remaining use and allocable expenses

    Any remaining spots, such as employee spots in a parking lot whose primary use is not for the general public, may then be determined by identifying spots by either actual or estimated usage.

Example 3:

Organization B, a church which also runs a school, owns a surface parking lot. B incurs $10,000 of total parking expenses. B's parking lot has 500 spots that are used by its congregants, students, visitors and employees, and 10 spots that are reserved for certain employees. During the normal hours of B's activities on weekdays, B usually has approximately 50 employees parking in the lot in non-reserved spots and approximately 440 non-reserved parking spots that are empty. During the normal hours of B's activities on weekends, B usually has approximately 400 congregants parking in the lot in non-reserved spots and 20 employees parking in the lot in non-reserved spots.

  • Step 1: Because B has 10 reserved spots for certain employees, $200 ((10/500) x $10,000 = $200) is the amount of total parking expense that is includible in UBTI for reserved employee spots. Thus, B must increase its UBTI by $200.
  • Step 2: Because usage of the parking spots varies significantly between days of the week, B uses a reasonable method to determine that the primary use of the remainder of B's parking lot is to provide parking to the general public because 90 percent (440/490 = .90) of the spots are used by the public during the weekdays and 95 percent (470/490) of the spots are used by the public on the weekends. The empty, non-reserved parking spots are treated as being provided to the general public. Thus, expenses allocable to these spots are excepted from under the primary use test. Therefore, only $200 of the expenses will result in an increase to UBTI. If B does not have gross income from any unrelated trades or businesses of $800 or more included in computing its UBTI (to reach the $1,000 filing threshold), B is not required to file a Form 990-T for that year.

Example 4:

Organization C is a hospital that owns a surface parking lot. C incurs $10,000 of total parking expenses. C's parking lot has 500 spots that are used by its patients, visitors, and employees. C has 50 spots reserved for management and has approximately 100 employees parking in the lot in non-reserved spots during the normal operating hours of the hospital.

  • Step 1: Because C has 50 reserved spots for employees, $1,000 ((50/500) x $10,000 = $1,000) is the amount of total parking expense that is nondeductible for reserved employee spots. Thus, C must increase its UBTI by $1,000.
  • Step 2: The primary use of the remainder of C's parking lot is to provide parking to the general public because 78 percent (350/450 = .78) of the remaining spots in the lot are open to the public. Thus, expenses allocable to these spots are excepted under the primary use test, and only $1,000 of the expenses will result in an increase in UBTI. C will need to add the $1,000 increase of UBTI to its gross income from unrelated trades or businesses.

Example 5:

Organization D owns its own surface parking lot. D incurs $10,000 of total yearly parking expenses. D's parking lot has 500 spots that are used by its customers and employees. D usually has approximately 50 employees parking in the lot in non-reserved spots during normal business hours on a typical business day. D usually has approximately 300 non-reserved parking spots that are empty during normal business hours on a typical business day.

  • Step 1: Because none of D's parking spots are exclusively reserved for employees, there is no amount to be specifically allocated to reserved employee spots.
  • Step 2: The primary use of D's parking lot is to provide parking to the general public because 90 percent (450/500 = .90) of the lot is used by the public. The 300 empty non-reserved parking spots are treated as provided to the general public. Thus, expenses allocable to these spots are excepted from the UBI calculation. Because the primary use of the parking lot is to provide parking to the general public, none of the $10,000 is considered UBI.

Example 6:

Organization E owns a surface parking lot. E incurs $10,000 of total parking expenses. E's parking lot has 500 spots that are used by its visitors and employees. E usually has approximately 400 employees parking in the lot in non-reserved spots during normal business hours on a typical business day. Additionally, E has 25 spots reserved for nonemployee visitors.

  • Step 1: Because none of E's parking spots are exclusively reserved for employees, there is no amount to be specifically allocated to reserved employee spots.
  • Step 2: The primary use of E's parking lot is not to provide parking to the general public because 80 percent (400/500 = .80) of the lot is used by its employees. Thus, expenses allocable to those spots are not excepted under the primary use test.
  • Step 3: Because 5 percent (25/500 = .50) of E's parking lot spots are reserved nonemployee spots, up to $9,500 ($10,000 x .95 = $9,500) of E's total parking expenses are subject to the UBI calculation.
  • Step 4: E must reasonably determine the employee use of the remaining parking spots during normal business hours on a typical business day and the expenses allocable to employee parking spots. If all 400 employees parked every day, then the calculation would be 400/475 x $9,500 = $8,000, which would be the amount of expense to be reported as UBTI.

IRS relief from estimated tax penalties:

Note that Notice 2018-100 provides tax-exempt organizations a waiver of underpayment of estimated income tax payments required to be made on or before Dec. 17, 2018, to the extent the underpayment of estimated income tax results from the changes to the tax treatment of qualified transportation fringes. This relief is available only to organizations that were not required to file a Form 990-T for the tax year immediately prior to the organization’s first tax year ending after Dec. 31, 2017. The relief is limited to tax-exempt organizations that timely file Form 990-T and timely pay the amount reported for the tax year for which relief is granted. To claim the waiver under Notice 2018-100, the tax-exempt organization must write “Notice 2018-100” on the top of its Form 990-T.

All tax-exempt organizations should address their parking situations immediately to determine their exposure under these rules. Documentation is key to supporting an organization’s conclusions as to the amount of parking expenses to be reported.

Finally, there is the possibility of legislative relief. A bill has been proposed in the House of Representatives that calls for a repeal of the Section 512(a)(7) parking rules that relate to non-profits. However, the time to effect passage is limited in this lame duck session of Congress. Whether the new Congress will pass legislation in 2019 providing either prospective or retroactive relief remains uncertain.  We will continue to monitor and provide further guidance as needed.

For more information on this topic, or to learn how Baker Tilly tax specialists can help, contact our team.

Green meadow
Next up

TCJA: Mining the tax benefits for natural resources holders