December 17, 2018 IRS notice provides interim guidance on determining tax treatment of qualified transportation fringe benefits as modified under TCJA In Notice 2018-99 (the Notice), the Treasury Department (Treasury) and Internal Revenue Service (IRS) provide interim guidance on the determination of qualified transportation fringe (QTF) parking expenses as disallowed deductions under Section 274(a)(4) or unrelated business taxable income (UBTI) under Section 512(a)(7). Both provisions were added to the Code by the Tax Cuts and Jobs Act of 2017 (TCJA). The Notice indicates that Treasury and IRS intend to publish proposed regulations on the determination of nondeductible parking expenses and other expenses for QTFs and the calculation of increased UBTI attributable to QTFs. In the meantime, taxpayers may use any reasonable method for determining the amount of nondeductible expenses under Section 274(a)(4) or the amount of the increase in UBTI under Section 512(a)(7). Taxpayers may rely on the guidance in the Notice, which sets forth a deemed reasonable method for allocating expenses and identifies certain methods as unreasonable. The Notice does not address the disallowance of commuting expenses under Section 274(l), which was also added to Section 274 by the TCJA. Background Section 274(a)(4) disallows any income tax deduction for the expense of providing a QTF to employees. Section 512(a)(7) treats the same expense as UBTI of a tax-exempt organization. Section 274(l) also separately disallows any income tax deduction for the cost of funding any employee travel between the employee's residence and place of employment (subject to a safety exception) without regard to whether the benefit is a QTF. Section 274(a)(4) (but not Section 274(l)) is subject to a number of exceptions, such as amounts treated as compensation, items available to the general public, and expenses for goods or services sold to customers. A QTF is one of the following four benefits provided by an employer to an employee: (1) transportation in a commuter highway vehicle between the employee's residence and place of employment, (2) any transit pass, (3) qualified parking, or (4) a bicycle commuting reimbursement (the Section 132 exclusion for which is currently suspended until 2026). Section 132(f) excludes the value of a QTF from an employee's gross income up to an indexed monthly limit (in 2018, this limit is $260/month). Parking is a QTF if the parking is provided by an employer 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. For these purposes, an employee is any current common law employee or statutory employee. Partners, 2% shareholders of S corporations, sole proprietors, and independent contractors are not employees for purposes of Sections 132 and 274. Guidance Expenses The Notice clearly states that disallowance/UBTI relates to the expense of providing a QTF, not its value, and identifies those expenses that are within the scope of the disallowance. For parking provided by a third party, the amount paid to a third party for employee parking is disallowed/UBTI, except to the extent that the amount is imputed in income because it exceeds the monthly exclusion limitation. For a parking facility owned or leased by the taxpayer, the taxpayer must use any reasonable method to determine expenses allocable to employee parking. These expenses include, but are not limited 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 or a portion of a rent or lease payment. The Notice expressly states, however, that depreciation is not an expense of providing a QTF. Additionally, 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. Allocation method The bulk of the Notice details a deemed reasonable method for allocating expenses to QTF. Generally, the four-step method allocates all expenses for reserved employee parking and typical employee usage to the disallowance/UBTI but provides an important exception for public use. Step 1: Disallowance for reserved employee spots Under the first step of the method, the taxpayer calculates the cost of reserved employee parking that is disallowed as a deduction or includible as UBTI. For example, if an employer incurs total expenses of $10,000 for a parking facility that has 500 parking spots, 50 of which are reserved for employees, the disallowed cost of the reserved spots is $1,000 ($10,000 x 50/500). In addition to including a reserved spot disallowance as the first step in a reasonable method, the Notice also treats a failure to disallow reserved spot expenses as an unreasonable method. Specifically, for tax years beginning on or after January 1, 2019, the Notice expressly deems a failure to allocate expenses to reserved employee spots to be an unreasonable allocation method. This rule, however, is tempered by a transition rule allowing a change in employee reserved spot designations (e.g., to decrease or eliminate reserved employee spots and thereby increase deductions or decrease UBTI) made by March 31, 2019, to be treated as applying retroactively to January 1, 2018. Step 2: Primary use test In the second step, the remaining parking spots are evaluated to determine whether the primary use of those spots is for the general public. Section 274(e)(7) exempts any deduction from Section 274(a)'s disallowances if the expense is for an item made available by the taxpayer to the general public. This exception has been interpreted to include customers and potential customers but not an exclusive list of guests. The Notice's primary-use test exempts the facility's remaining parking spots if the general public's typical usage of those spots during normal business hours on a typical business day exceeds 50% of the actual or estimated usage of those spots. The Notice clarifies that the normal hours of the exempt organization's activities on a typical day is the defining period, as opposed to normal business hours for for-profit employers. The Notice treats spots as available to the general public if the spots are typically empty, or used by customers, 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. Spots typically used by employees, partners or independent contractors of the taxpayer are not treated as available to the general public. So, for example, a 500-space parking facility (with no reserved parking) in which employees typically use 50 parking spots and the remaining spots are typically empty or occupied by visitors would satisfy the primary use test. In such a scenario, all QTF costs for that parking facility would be exempt from disallowance/UBTI. As a practical matter, divvying up parkers between the general public bucket and the nonpublic bucket may be unclear at times. For example, an independent contractor (nonpublic under the Notice) is also an individual delivering services (general public under the Notice). Presumably, the Notice means to treat permanently stationed independent contractors (such as leased employees) as nonpublic but other independent consultants as public. Further clarity to distinguish between general public and nonpublic parkers may be needed. Step 3: Carve-out for parking reserved for nonemployees The third step, which is necessary only if the facility fails the primary use test, carves out costs of reserved nonemployee parking from the disallowance. If the taxpayer reserves parking spaces for nonemployees such as visitors, customers, partners, sole proprietors, or 2% shareholders of S corporations, the costs of those nonemployee reserved spots is not disallowed or subject to UBTI. Allowed costs are allocated to these spots in the same manner that disallowed costs are allocated to reserved employee spots; that is, the taxpayer would multiply its remaining total parking expenses by the ratio of reserved nonemployee spots over remaining spots (not including reserved employee spots) to determine the amount exempt from disallowance/UBTI. Step 4: Allocation of remaining costs based on typical usage In step four, any remaining costs are allocated based on typical usage. The taxpayer reasonably determines the employee use of the remaining parking spots during normal business hours on a typical business day (or, in the case of an exempt organization, during the normal hours of the exempt organization's activities on a typical day), assigning a percentage to the employee use to be multiplied by the remaining costs. For example, if $10,000 in costs and 50 spots have not been allocated in the first three steps, and the taxpayer determines that 25 of those remaining spots are typically occupied by employees during normal business hours on a typical business day, then $5,000 is disallowed ($10,000 x 25/50). Actual or estimated usage may be based on the number of spots, number of employees, hours of use, or other reasonable measures. Imputed income addback Finally, the examples in the Notice (specifically, example 2) demonstrate that an amount imputed as income to an employee because it is over the Section 132(f) exclusion limit ($260 per month) may be credited (under Section 274(e)(2)) to recoup the disallowed amount dollar for dollar. For example, if $10,000 in expenses were disallowed but $3,000 over the exclusion limit was imputed as income to employees, the taxpayer may reduce the disallowance to $7,000. The $3,000 amount over the exclusion limit is not subject to the Section 274(a)(4) disallowance, and thus remains deductible and excludible from UBTI. While the Notice does not specifically address Section 274(l), which disallows deductions for commuting expenses, this example demonstrating the addback for amounts included in employees' income for parking creates an inference on the interpretation of Section 274(l). It suggests that Treasury and IRS do not view Section 274(l) as applicable to parking because if Section 274(l) applied to parking, it would seem to prohibit this addback in the example. The Notice makes clear that the value of parking provided over the Section 132(f) exclusion limit avoids Section 274(a)(4). If Section 274(l) applied, however, the addback would nevertheless be nondeductible. Thus, the addback appears to indicate that parking is outside the scope of Section 274(l). Although the Notice discusses the treatment of expenses for a QTF when income is imputed for value over the QTF limit, the Notice does not address the treatment of such expenses when income is imputed for value below the limit. The Notice also does not address a scenario in which the employer charges an employee for parking that could have been excluded from income as a QTF. Guidance for tax-exempt organizations Because Section 512(a)(7) is premised on whether a disallowance would apply under Section 274, most of the guidance provided by the Notice applies equally to taxable businesses and tax-exempt organizations. The Notice does, however, provide a few specifics for only tax-exempt organizations. Notice 2018-67 (Tax Alert 2018-1700), which focuses on the UBTI calculation under Section 512(a)(6) for exempt organizations with more than one unrelated trade or business, states that providing a QTF is not a separate unrelated trade or business. Notice 2018-99 reiterates this point and specifically states that a tax-exempt organization with only one unrelated trade or business can reduce the increase to UBTI under Section 512(a)(7) to the extent that the deductions directly connected with the carrying on of that one unrelated trade or business exceed the gross income derived from the unrelated trade or business. Thus, a QTF is not an unrelated trade or business subject to compartmentalization under Section 512(a)(6) and unrelated trade or business losses may be used to offset UBTI generated by Section 512(a)(7) if the exempt organization engages in only a single unrelated trade or business. If the taxpayer has more than one unrelated trade or business, it becomes subject to Section 512(a)(6), and thus losses from these trades or businesses likely could not be used to offset Section 512(a)(7) UBTI. The Notice also notes that Section 512(b)(12) "provides a specific deduction of $1,000 as a modification to the UBTI otherwise determined under Section 512(a)." Thus, an organization with gross UBTI less than $1,000 (before the deduction) in a given tax year would not have a UBTI liability and would not be required to file Form 990-T, Exempt Organization Business Income Tax Return, for that tax year. In conjunction with Notice 2018-99, the IRS also released Notice 2018-100. Notice 2018-100 waives the penalty for underpayment of estimated tax for certain tax-exempt organizations that must pay estimated tax due to the UBTI created by Section 512(a)(7). See Tax Alert 2018-2498. Request for comments The Notice makes a general request for comments and specifically asks for comments on:
Comments are due February 22, 2019. Implications The Notice's conclusion that a parking facility's depreciation deduction is not an expense of providing a QTF is a somewhat unexpected, but welcome, interpretation that would significantly reduce the tax exposure of parking facility owners. Nevertheless, the list of included expenses is considerable. Taxpayers should review the list to determine whether they need to consider additional expenses in calculating a disallowance or determining UBTI. Although the Notice is detailed in its treatment of the allocation of expenses of a parking facility, it provides no clarification concerning the allocation of lease expenses between office space and associated parking, which are often commingled in the lease document. As a result, taxpayers are left to reach their own reasonable interpretations on that question until further guidance is issued. The Notice's interpretation of the Section 274(e)(8) public-use exception may benefit certain taxpayers with a high volume of customers or visitors who park in their parking facilities. Nevertheless, taxpayers that fail to meet the threshold will often do so due to location, lot size and the nature of their businesses; as a result, the impact of the tax is somewhat arbitrary. Additionally, taxpayers that reserve no spots for employees and charge nothing for usage of the lot will incur a tax if employee usage is greater than 50%. This result was unexpected and will be unfavorable for many taxpayers that have not viewed their parking lots as QTFs. Any organization with reserved employee spots should consider redesignating the spots as available to nonemployees by March 31, 2019, particularly if redesignating those spots would allow the usage of the facility to qualify for the public-use exception. Stakeholders have asked to treat the expense of providing a QTF as the lesser of cost or value. This notion was clearly refuted by the Notice, which repeatedly distinguishes the cost of providing a QTF from the value of the QTF. Additionally, the Notice specifically deems the use of fair market value of employee parking to determine expenses allocable to employee parking in a parking facility owned or leased by a taxpayer to be unreasonable. This deeming rule is particularly disappointing to taxpayers that might have used fair market value as a benchmark for allocating lease costs between office space and associated parking. For tax-exempt organizations, the same methods, principles and examples provided within the Notice also apply to calculating the increase in UBTI under Section 512(a)(7). The Notice also provides some welcome clarification to the relationship between the QTF additions to UBTI under Section 512(a)(7) and the new rules regarding separate trades or businesses under Section 512(a)(6). The Notice is clear that an increase in UBTI under Section 512(a)(7) is not an unrelated trade or business to be separately calculated under Section 512(a)(6). Therefore, taxpayers with only one unrelated trade or business may use any current year loss to reduce any UBTI under Section 512(a)(7) (until further guidance is issued), which is also implied in the draft 2018 Form 990-T instructions. Any QTF expenses directly connected with an unrelated trade or business that is regularly carried on by the organization should be analyzed for potential disallowance under Section 274(a)(4). These expenses would not increase UBTI but would be a disallowed deduction, as the rules apply to for-profit organizations. Although the net result may be the same, organizations should apply the same reasonable basis under Treas. Reg. Section 1.512(a)-1 when determining those expenses that are directly connected to an unrelated trade or business activity. Although the Notice reduces the expected exposure of certain taxpayers, it also increases the expected exposure of other taxpayers. Nevertheless, it does mark a significant effort by Treasury and the IRS to provide a measure of clarity and a reduction in the somewhat arbitrary impact of the tax. The Notice also leaves open significant questions that are unlikely to be answered before the first set of returns for tax years to which the new Section 274(a)(4) and 512(a)(7) rules apply must be filed. ——————————————— — For more information about EY's Exempt Organization Tax Services group, visit us at www.ey.com/ExemptOrg. ———————————————
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