While the Tax Cuts and Jobs Act (TCJA) included several taxpayer-favorable provisions, it also included many revenue raisers to pay for the tax cuts. One such revenue raiser was a change to Internal Revenue Code Section 274 to no longer allow a deduction for the expense of any qualified transportation fringe (QTF) paid or incurred after December 31, 2017, provided to an employee by the taxpayer. The disallowance includes benefits provided through a compensation reduction agreement. The QTF definition includes qualified parking.
Many business taxpayers were puzzled on how to prepare the calculation showing the amount of fringe benefits that should be excluded as a parking QTF. Not-for-profit organizations also were wondering how to perform this calculation, as the TCJA included a similar provision under §512 to increase unrelated business taxable income (UBTI) of an exempt organization by any amount paid or incurred after December 31, 2017, for any QTF not allowable by §274. Fortunately, the IRS recently provided some welcome relief by issuing Notice 2018-99 (Notice), which provides interim guidance on QTFs and how to calculate the disallowed amount.
Types of Parking Arrangements
The Notice presents two types of parking arrangements that may occur between a taxpayer and an employee. The first type occurs when a taxpayer pays a third party for employee parking spots so its employees may park at the third party’s parking lot or garage. In this situation, the §274 disallowance generally is calculated as the taxpayer’s total cost paid to the third party. One stipulation that must be met is the amount of QTFs provided by an employer to any employee that can be excluded from gross income monthly cannot exceed the maximum inflation-adjusted dollar amount of $260 per employee for 2018. The amount that exceeds this threshold is treated as compensation to the employee and is excluded from the taxpayer’s §274 calculation.
The second type of parking arrangement presented in the Notice occurs when a taxpayer owns or leases all or a portion of a parking facility. The Notice clarifies that a parking facility may include garages and other structures on or near a location from which employees commute to work. Any reasonable method in determining the disallowance can be used; however, the Notice includes a four-step approach the IRS deems reasonable (as outlined below). For purposes of the four-step method, the number of spots within parking facilities that are leased or owned within a single geographic location may be aggregated. The Notice also specifically states that using the value of employee parking isn’t a reasonable method.
For purposes of the reasonable method outlined in the Notice, “total parking expenses” include, but are not limited to, repairs, maintenance, utility costs, insurance, property taxes, security, interest, parking lot attendant expenses, cleaning, landscape costs, rent or lease payments (or a portion of a rent or lease payment if not broken out separately) and snow, ice, leaf and trash removal. The Notice also clarifies that a deduction for an allowance for depreciation on a parking structure isn’t considered a parking expense. 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, also are not included.
Four-Step Reasonable Method for Taxpayer-Owned Parking Facilities
Using the four-step methodology outlined in the Notice, a taxpayer’s §274 disallowance may be calculated as follows:
- First, the taxpayer must calculate the disallowance related to parking spots exclusively reserved for the taxpayer’s employees, e.g., “Employee Parking Only” signs. The number of these spots is taken as a percentage of total spots and multiplied by the total parking expenses for the parking facility. The result is the disallowed amount attributable to reserved employee spots. For taxable years beginning on or after January 1, 2019, a method that fails to allocate expenses to reserved employee spots can’t be considered a reasonable method; however, taxpayers have until March 31, 2019, to decrease or eliminate their reserved employee spots and have the spots treated as not reserved retroactively to January 1, 2018, for purposes of this calculation.
- Next, the taxpayer calculates the primary use of the remaining spots. Primary use is tested during normal business hours on a typical business day. If the primary use of the remaining spots is to provide parking to the general public more than 50 percent of the time, then the remaining amount of the total parking expenses isn’t included in the disallowed amount. Otherwise, taxpayers should continue the calculation in step three. For purposes of the Notice, the “general public” includes, but isn’t limited to, customers, clients, visitors, delivery drivers, health care facility patients, educational institution students and religious organization congregants. Employees, partners and independent contractors of the taxpayer aren’t considered part of the general public.
- If the primary use test isn’t met, the taxpayer calculates the allowance for reserved nonemployee spots—those exclusively reserved for visitors and customers, partners, sole proprietors, and 2 percent shareholders of S corporations, e.g., “Customer Parking Only” signs. Taxpayers with nonemployee spots can take the percentage of those spots in relation to the remaining total parking spots after step one and multiply it by the remaining parking expenses. This amount isn’t included in the disallowed total.
- The final step in the calculation—if any parking expenses remain uncategorized after Steps 1 to 3—is to reasonably determine the employee use of the remaining parking spots and related expenses allocable to those spots. Permissible methods for determining this amount include specifically identifying the number of employee spots according to actual or estimated usage based on the number of spots, employees, hours of use or other measures.
The Notice provides several examples to demonstrate how the disallowance is calculated. The following example from the Notice illustrates the interaction between the limitation on an employee’s QTF income exclusion and an employer’s disallowance under §274.
Taxpayer A pays B, a third party who owns a parking garage across the street from A, $300 per month for each of A’s 10 employees to park in B’s garage, or $36,000 per year. Of the $300 per month paid for parking for each employee, $260 is excludible from income under §132 and none of the §274 exceptions apply to this amount. Thus, $31,200 is subject to the §274 disallowance. The excess amount of $40 per employee per month is not excludible under §132 and is treated as compensation and wages. As a result, the §274 exception applies to this amount. Thus, $4,800 is not subject to the §274 disallowance and remains deductible.
The next example demonstrates the four-step methodology for calculating the §274 disallowance.
Taxpayer E, a manufacturer, owns a surface parking lot adjacent to its plant. E incurs $10,000 of total parking expenses. E’s parking lot has 500 spots that are used by its visitors and employees. E has 50 spots reserved for management and has approximately 400 employees parking in the lot in nonreserved spots during normal business hours on a typical business day. In addition, E has 10 reserved nonemployee spots for visitors.
- Because E has 50 reserved spots for management, $1,000 ((50/500) x $10,000 = $1,000) is the amount of total parking expenses that is nondeductible for reserved employee spots.
- The primary use of the remainder of E’s parking lot is not to provide parking to the general public because 89 percent (400/450 = 89 percent) of the remaining parking spots in the lot are used by its employees. Thus, expenses allocable to these spots are not excepted from the §274 disallowance under the primary use test.
- Because 2 percent (10/450 = 2.22 percent) of E’s remaining parking lot spots are reserved nonemployee spots, the $200 allocable to those spots ($10,000 x 2 percent) is not subject to the §274 disallowance and continues to be deductible.
- 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.
Application to Not-for-Profit Organizations
As noted above, tax-exempt employers must increase their UBTI by any amount of QTF paid that is disallowed as a deduction under §274. This amount can be calculated using the same steps as a for-profit organization. In the first example above, assuming Taxpayer A is a tax-exempt organization, it would include $31,200 as an increase in UBTI under §512. On the current draft of the 2018 Form 990-T, disallowed QTFs will be reported on a separate line from all other income and expenses.
The Notice also confirms a tax-exempt organization with only one unrelated trade or business can offset an increase in UBTI due to disallowed QTF expenses by any net loss from the unrelated trade or business. Read more about the previous guidance released related to UBTI reporting in this BKD Thoughtware® article.
The IRS also recently announced it will provide estimated tax penalty relief to certain tax-exempt organizations that offer QTFs and weren’t required to file a Form 990-T during the previous filing season. See Notice 2018-100 for more information on how tax-exempt organizations may qualify for this relief.
The IRS and U.S. Department of the Treasury intend to publish proposed regulations under §§274 and 512. Those proposed regulations will include further guidance on the determination of nondeductible parking expenses and other expenses for QTFs and the calculation of increased UBTI attributable to QTFs. Public comments in response to the Notice may be submitted through February 22, 2019.
Both for-profit and tax-exempt taxpayers should review this notice and determine potential effects on their 2018 tax liability due to the qualified parking disallowance. Furthermore, taxpayers should evaluate whether to make a change in signage for reserved spaces by March 31, 2019, to take advantage of the retroactive relief the Notice provides and potentially achieve a more favorable result under the four-step method.
For more information, contact Julia, Kyle or your trusted BKD advisor.