The definition of reform is “to make changes in something in order to improve it.” We certainly all know “Tax Reform” is a “change”. However, we are still trying to determine if it really improves things. The reality of reform (specifically Tax Reform) is some things improve, some things stay the same and others take a hit. Commuter Benefits took a slight hit as a result of Tax Reform, but are certainly not “down for the count”. Read on to understand the interaction of Tax Reform and Commuter Benefits.
What does Tax Reform say in regards to commuter benefits?
Among other things, the Tax Reform Bill limits an employer’s ability to deduct the cost of transportation and parking benefits as a business expense. This was done to simplify some of the deductions employers were taking. In exchange for the loss in deducibility of certain items, the overall corporate tax rate was reduced from 35% to 21%. While the deductibility of transportation and parking expenses was removed, pre-tax employee elections for mass transit and parking expenses continue to be available.
What does that really mean?
To understand the real impacts of Tax Reform and commuter benefits, it is best to consider commuter benefits in one of three ways:
- Direct Payment of Parking/Mass Transit expenses by an employer
- Employer Subsidy of Parking/Mass Transit expense by an employer
- Employee Pre-tax Elections for Parking/Mass Transit expenses
Direct Payment of Parking/Mass Transit expenses by an employer
Through a direct payment arrangement, the employer directly pays for parking and/or mass transit expenses to the provider. They may submit payment to a parking lot provider or buy transit passes to distribute to employees. The employer is typically paying this as a direct business expense. In the past, this would have been deductible. Under the new law, the deduction is no longer available.
Example 1 (Prior to tax reform)
You have gross business revenue totaling $100,000 and a parking expense of $1,000. You reduce your gross revenue by $1,000 to get your taxable revenue of $99,000. You pay 35% tax on $99,000 or $34,650.
Example 1 (Post tax reform)
Under tax reform, you will no longer deduct the $1,000 parking expense as a business expense. You still have gross business revenue totaling $100,000. However, your taxable revenue remains $100,000. You then pay 21% tax on $100,000 or $21,000, an overall reduction of $13,650.
Employer Subsidy of Parking/Mass Transit expenses by an employer
Under an employer subsidy arrangement, the employer provides a set amount(s) to employees to offset parking and/or mass transit expenses. While the payment to the parking or mass transit providers is likely initiated by the participant, the subsidy is likely treated as a general business expense. In the past, this would have been deductible. Under the new law, the deduction is no longer available. (NOTE: The end result is the same whether it is directly paid by the employer or initiated by the employee.)
Example 2 (Prior to tax reform)
Using the same scenario above, your gross business revenue totals $100,000. You pay $1,000 as an employee parking subsidy. You reduce your gross revenue by $1,000 to get your taxable revenue of $99,000. You paid 35% tax on $99,000 or $34,650.
Example 2 (Post tax reform)
In a post tax-reform state, you would no longer deduct your $1,000 parking subsidy expense. So, your gross business revenue totaling $100,000 is taxable. You now pay 21% tax on $100,000 or $21,000, an overall reduction of $13,650.
Employee Pre-tax Deductions for Parking/Mass Transit expenses
The employee makes a pre-tax deduction for anticipated mass transit and/or parking expenses. The employer reduces the employees’ taxable wages and the election amounts are moved to a separate account/allocation for the employees to use specifically for parking / mass transit expenses. The employee pays for mass transit or parking with his or her pre-tax dollars.
Simple enough! Or maybe not. Since tax reform was released, there have been two dominating opinions regarding the tax treatment of employee pre-tax mass transit and parking deductions. So, we will lay out the cases. Benefit Resource is not a tax advisor. Always consult your tax advisor for any specific advice or recommendations.
Position 1: Maintain Status Quo
Typically, an employer would take their gross wage expense and deduct it from gross revenue as a general business expense. This gives them the taxable revenue amount. Then, employees would take their pre-tax deductions for things such as benefits, 401K and pre-tax mass transit or parking. The employer pays taxes on their taxable revenue. Additionally, the employer saves 7.65% in FICA on any pre-tax deductions employees make.
Gross revenue = $100,000
Wage expense = $20,000
Taxable revenue = $80,000
Employer pays taxes on $80,000 at 21%
Employee Pre-tax Transit/Parking Deductions = $1,000
Employer saves 7.65% on $1,000
This perspective indicates that there is no specific guidance to suggest that employee pre-tax mass transit and parking elections need to change. Further, absent any guidance, employers should maintain their current procedures regarding calculating wage expense. If at a later date, guidance is released to indicate wage expense should be adjusted by the amount of employee pre-tax deductions, you have the ability to make a one-time annual adjustment rather than implementing a per payroll adjustment now.
Position 2: The Conservative Adjustment
There is a conservative position that suggests employers should adjust their gross wage expense by the amount of employees’ pre-tax mass transit and parking elections. Wage expense would be decreased by this amount and subject to taxable revenue.
Gross revenue = $100,000
Gross wage expense = $20,000
Employee Pre-tax Transit/Parking Deductions = $1,000
Adjusted wage expense = $19,000
Taxable revenue = $81,000
Employer pays taxes on $81,000 at 21%
Employer saves 7.65% on $1,000
Under both positions, the deductions made by employees continue to be tax-free for the employee and continue to provide FICA savings to the employer.
So what should you do regarding Tax Reform and Commuter Benefits?
While we are not tax advisors, we are generally recommending employers (at a minimum) continue to offer pre-tax mass transit and parking deductions for employees. We encourage you to consult a tax advisor for the finer details and to clarify any impacts as they relate to employer-paid transportation or parking benefits.
Employees value Commuter Benefits. We have seen a growing interest and use of these benefits in recent years. Additionally, local ordinances regarding commuter benefits are still active. You are likely subject to one or more of these local transit benefit ordinances if you have employees working in New York City, Washington D.C. or the San Francisco Bay Area.
As more clarity is provided, we will keep you updated. We encourage you to subscribe to the BRiBlog to get the latest news and updates.
