Benefits Spotlight: Tax-Free Commuter Benefits

A relatively new and Congressionally approved benefit for employees is the provision of transportation benefits ' such as parking; subway, bus, train fare, or vanpooling ' on a tax-free basis. By reducing the cost of commuting, an employer can reap many rewards including appreciation of employees of their tax savings, reduced employment taxes paid by the employer and even reduced stress by employees. However, although Congress attempted to allow employers to provide tax-free commuter benefits to employees in a simple fashion, there are some esoteric rules of which employers should be aware.

Overview of IRC '132(f)

Internal Revenue Code (IRC) '132 allows employers to offer qualified transportation fringe benefits to their employees on a pre-tax basis. IRC '132(f) defines the term “qualified transportation fringe” as any of the following provided by an employer to an employee:

• Transportation in a commuter highway vehicle if such transportation is in connection with travel between the employee's residence and place of employment;
• Any transit pass; and
• Qualified parking.

Employers can exclude from employees' monthly wages an amount not in excess of $195 for qualified parking for tax years beginning in 2004. In addition, the monthly limitation for transportation in a commuter highway vehicle and any transit pass is $100 for tax years beginning in 2004.

The employer can provide such amount in addition to, or in lieu of, employees' salary. The benefits can be provided in the form of a reimbursement for an expense already paid by the employee (subject to certain limitations – see the discussion below), or alternatively, and much more simply, the benefit can be paid for directly by the employer. Elective payments for transportation benefits by employees are not permitted to be part of an IRC '125 cafeteria plan. However, roughly speaking, an employer that allows for elective employee contributions in effect is establishing a “mini” cafeteria plan for commuter benefits only.

Advantages of Tax Free Commuter Benefits

The rationale for providing an IRC '132(f) commuter benefit program is similar to that for providing medical, dental, and life insurance benefits through a cafeteria plan. The plans provide employees with more cash in pocket because of the tax savings, which can reach more than 35% of the benefit. In addition, the cost of plan implementation by the employer is often more than offset by the employer's FICA savings. For example, an employer with 1000 employees spending $1 million per year on parking and transit passes will net a FICA tax savings of about $75,000. This amount could be used to pay for the costs of establishing and maintaining the commuter benefit program.

Cash Reimbursements of Commuter Benefits

IRC '132(f)(3) provides, in general, that qualified transportation fringe benefits include cash reimbursement by an employer to an employee for expenses incurred or paid by an employee for qualified parking or transportation in a commuter highway vehicle. However, it goes on to say that the term qualified transportation fringe benefit includes a cash reimbursement for a transit pass only if a voucher or similar item, which may be exchanged only for a transit pass, is not “readily available” for direct distribution by the employer to the employee. Treas. Reg. '1.132-9, Q&A 16(b)(5) provides a 1% test for determining whether a voucher and/or transit pass is “readily available” under IRC '132(f). This test became effective on January 1, 2004.

In most metropolitan areas, employers can obtain vouchers and/or transit passes at face value (ie, the cost to the employer is zero), and therefore, such vouchers and transit passes are readily available under the 1% test. However, it is our understanding that many employers administer this type of transportation benefit on a cash reimbursement basis. Effective Jan. 1, 2004, such employers must begin distributing transit passes to their employees in order to maintain the qualified status of their plans.

Conclusion

Pre-tax transportation benefits are a fantastic benefit to provide employees. However, there are some complexities to providing such benefits (some of which are discussed above but others are beyond the scope of this article). A simple solution to avoiding the complexities of IRC '132(f) rules is to use a direct pay approach by the employer and to consider the use of a third party administrator.

A relatively new and Congressionally approved benefit for employees is the provision of transportation benefits ' such as parking; subway, bus, train fare, or vanpooling ' on a tax-free basis. By reducing the cost of commuting, an employer can reap many rewards including appreciation of employees of their tax savings, reduced employment taxes paid by the employer and even reduced stress by employees. However, although Congress attempted to allow employers to provide tax-free commuter benefits to employees in a simple fashion, there are some esoteric rules of which employers should be aware.

Overview of IRC '132(f)

Internal Revenue Code (IRC) '132 allows employers to offer qualified transportation fringe benefits to their employees on a pre-tax basis. IRC '132(f) defines the term “qualified transportation fringe” as any of the following provided by an employer to an employee:

• Transportation in a commuter highway vehicle if such transportation is in connection with travel between the employee's residence and place of employment;
• Any transit pass; and
• Qualified parking.

Employers can exclude from employees' monthly wages an amount not in excess of $195 for qualified parking for tax years beginning in 2004. In addition, the monthly limitation for transportation in a commuter highway vehicle and any transit pass is $100 for tax years beginning in 2004.

The employer can provide such amount in addition to, or in lieu of, employees' salary. The benefits can be provided in the form of a reimbursement for an expense already paid by the employee (subject to certain limitations – see the discussion below), or alternatively, and much more simply, the benefit can be paid for directly by the employer. Elective payments for transportation benefits by employees are not permitted to be part of an IRC '125 cafeteria plan. However, roughly speaking, an employer that allows for elective employee contributions in effect is establishing a “mini” cafeteria plan for commuter benefits only.

Advantages of Tax Free Commuter Benefits

The rationale for providing an IRC '132(f) commuter benefit program is similar to that for providing medical, dental, and life insurance benefits through a cafeteria plan. The plans provide employees with more cash in pocket because of the tax savings, which can reach more than 35% of the benefit. In addition, the cost of plan implementation by the employer is often more than offset by the employer's FICA savings. For example, an employer with 1000 employees spending $1 million per year on parking and transit passes will net a FICA tax savings of about $75,000. This amount could be used to pay for the costs of establishing and maintaining the commuter benefit program.

Cash Reimbursements of Commuter Benefits

IRC '132(f)(3) provides, in general, that qualified transportation fringe benefits include cash reimbursement by an employer to an employee for expenses incurred or paid by an employee for qualified parking or transportation in a commuter highway vehicle. However, it goes on to say that the term qualified transportation fringe benefit includes a cash reimbursement for a transit pass only if a voucher or similar item, which may be exchanged only for a transit pass, is not “readily available” for direct distribution by the employer to the employee. Treas. Reg. '1.132-9, Q&A 16(b)(5) provides a 1% test for determining whether a voucher and/or transit pass is “readily available” under IRC '132(f). This test became effective on January 1, 2004.

In most metropolitan areas, employers can obtain vouchers and/or transit passes at face value (ie, the cost to the employer is zero), and therefore, such vouchers and transit passes are readily available under the 1% test. However, it is our understanding that many employers administer this type of transportation benefit on a cash reimbursement basis. Effective Jan. 1, 2004, such employers must begin distributing transit passes to their employees in order to maintain the qualified status of their plans.

Conclusion

Pre-tax transportation benefits are a fantastic benefit to provide employees. However, there are some complexities to providing such benefits (some of which are discussed above but others are beyond the scope of this article). A simple solution to avoiding the complexities of IRC '132(f) rules is to use a direct pay approach by the employer and to consider the use of a third party administrator.