New tax laws are always full of surprises. Take the recent Tax Cuts and Jobs Act (“Act”), the tax law recently passed by Congress and signed by the President. Although the lower marginal rates for businesses and arguments about whether the middle class will benefit from the Act have dominated the news, the Act’s treatment of employer deductions for parking expenses is certainly a surprise for a Republican-authored bill.
Effective January 1, 2018, the Act eliminates the tax deduction benefit that has long been available to employers that subsidize their employees’ transit and parking expenses. For years employers could provide or pay for parking or transit passes (worth up to $255 a month to employees in 2017) as a tax-free benefit to help pay for their employees’ commuting expenses, and then deduct those costs from their business taxable income.
Apparently due to a belief that the new, lower business income tax rate justified eliminating other deductions, Congress removed several business income tax breaks as being no longer necessary. One of those tax breaks was the employee transit/parking benefit. Under the Act, employers can still provide parking or transit passes to employees, but the employer will no longer get to deduct the costs of that benefit.
Any arrangement where the employer pays for employee parking, no matter how structured, will mean a non-deductible expense for the employer. Parking is employer-provided if:
- It is on property that the employer either owns or leases,
- The employer pays someone else (such as their landlord or a parking lot/garage owner) for the parking, or
- The employer reimburses the employee for parking expenses.
Consider a good-sized employer, who typically leases a large parcel of land and a building. The employer does not charge its customers for parking, but the employer also allows employees to park in a designated area of the “free” parking, also at no charge. Under the new “no deduction” rules, the IRS could argue that if employees are parking on an employer-provided space, then a portion of the rent for the land paid by the employer must be non-deductible, based on the proportionate “free” parking area used by the employees. This change will affect every business that has employees come to the business premises to work, no matter what the current arrangement. For example, a downtown business that leases spaces in a neighboring parking garage for its employees, either as part of its office lease or a separate lease, will now find that under the Act, the cost of that lease is now non-deductible.
Employers who wish to avoid the loss of the tax deduction or the after-tax imposition of the parking cost on their employees will need to create a method to continue providing tax-deductible parking to employees. The only solution to this problem that we see (pending any Congress-approved technical correction to the Act or enactment of a transition period) is the establishment of a “Qualified Transportation Compensation Reduction Plan.” Here’s how the plan would work.
First, employees would be required to pay for their own parking. The employer would then increase each employee’s compensation by the cost of the periodic parking charge. The employee would then elect to participate in the employer’s “Qualified Transportation Compensation Reduction Plan.” Under the Plan the employer deducts from the employee’s paycheck (pre-tax, as allowed under IRC §132(f)) the periodic parking cost and forwards that amount to the parking lot/garage owner on behalf of the employee. Since the employer gets a deduction for wages paid to its employee, its expenses are fully deductible. The employee does not recognize any additional income because the employee has elected to have the increased wages deducted pre-tax and applied toward the employee’s periodic parking expense, as allowed by current law.
However, what was once a simple arrangement between employers, their landlords or parking lot/garage owners and their employees just got very complex. Parking lot/garage owners will now have to have individual parking contracts with each employee, even though payment may come in the form of a single check from the employee’s employer, who has collected the pre-tax deductions from employee paychecks. Clearly, the parking cost must be separately paid from the employer’s other property lease charges. Although this arrangement might eventually be worked out between employers and their landlords and parking lot/garage owners, it certainly won’t happen right away, even though the law becomes effective on January 1. For a large employer with hundreds or thousands of employees, it may require a careful cost-benefit analysis. How the arrangement will work for a large employer that has employees parking in a common lot with customers is unclear.
Note also that this deduction denial is not limited only to taxable employers: it also applies to tax-exempt employers. The value of the parking space/transit pass paid by the tax-exempt employer for its employees becomes unrelated business taxable income, subject to taxation at 21% (matching the business income tax rate). For tax-exempt organizations the new law change creates the worst possible outcome – the organization pays for the employees’ parking cost, then has to pay income tax (at 21%) on the amount it paid for the employee parking.
We are available to discuss options and alternatives and to help establish appropriate plans for those employers who are looking to preserve their business deductions.