Congress and the IRS have expanded the availability and procedures for maximizing the income tax and FICA tax exclusion for mass transit benefits, but immediate action is required to satisfy the IRS special relief provisions for 2014 as well as to qualify for the anticipated expansion of the maximum 2015 tax benefits for the mass transit component of qualified transportation fringe benefits.
One of the most widely used and highly valued employee fringe benefits is the qualified transportation fringe (QTF) benefit. Recent actions from “inside the Beltway” have significantly affected tax-favored mass transit benefits, including Internal Revenue Service (IRS) Notice 2015-2 issued on January 9 in response to last month’s enactment of the Tax Increase Prevention Act of 2014 (TIPA). Notice 2015-2 directly affects the favorable tax treatment of mass transit benefits provided in 2014, but its relief provisions are available only for those employers whose payroll tax departments take immediate action to implement TIPA. Separately, Notice 2015-2 and the TIPA amendments indirectly highlight the immediate need to modify QTF election procedures if an employer seeks to maximize the favorable employer and employee tax treatment for mass transit benefits provided in 2015.
Background
The Internal Revenue Code offers many tax-favored employee fringe benefits, including a monthly exclusion from income and wages for employer-provided QTF benefits, such as mass transit benefits (typically in the form of transit passes) and qualified parking benefits. Although at odds with Congress’s underlying desire to increase the use of mass transit, the maximum monthly mass transit benefit has historically been far less than the monthly qualified parking exclusion. Between 2010 and 2013, Congress created parity between these two types of QTF benefits by raising the monthly mass transit exclusion to the same level as the parking exclusion. This parity expired at the end of 2013, resulting in an immediate reduction of the monthly mass transit exclusion from $245 to $130 for all of 2014.
Last month’s enactment of TIPA included a provision that retroactively raises the mass transit exclusion and restores parity between mass transit and parking benefits effective January 1, 2014 for all of calendar year 2014, but not for 2015 ( read more about last month’s year-end legislation). For some employees who commute using mass transit, the TIPA amendments potentially mean hundreds of dollars in income tax and Federal Insurance Contributions Act (FICA) tax savings and refunds for 2014. For employers, this may also include significant FICA tax savings for last year. Because Congress restored parity only for 2014, employers must immediately take separate steps to preserve the maximum mass transit exclusion for 2015 in anticipation of future congressional relief.
2014—Retroactive Payroll Changes
Transit benefits in excess of $130 per month (but less than $250 per month) are retroactively excludable for a maximum retroactive wage reduction of $1,440 per employee. Notice 2015-2 outlines administrative procedures to implement this retroactive mass transit increase, including important relief procedures available only for employers that take immediate action. Some of the most relevant payroll tax concepts and changes addressed in Notice 2015-2 are highlighted below:
The retroactive exclusion applies whether the transit benefits were provided by employer funds or through employee salary reduction arrangements.
Special administrative relief and simplified correction procedures are added to correct excess employer and employee FICA taxes for those employers seeking to implement the TIPA changes on a streamlined basis..
Special Form W-2 information reporting and correction procedures to accurately reflect the adjusted taxable wages and FICA and Federal Income Tax Withholding amounts are added.
The unique correction and reporting procedures for the Additional Medicare Taxes imposed on highly compensated employees are summarized.
Special administrative procedures for employers that correct the excess transit pass issue after January 31 but prior to filing Forms W-2 with the Social Security Administration are summarized.
The “normal,” more complex correction procedures apply if the changes are not implemented using the Notice’s special procedures.
Although Notice 2015-2 provides relief for mass transit benefits previously elected in 2014, it does not allow employees to make retroactive transit benefit elections for 2014. Rather, it changes the tax treatment of the 2014 salary reductions and disbursements that actually occurred in 2014. As such, TIPA’s retroactive parity provisions will likely only affect two types of employers for 2014: (i) those employers with QTF plans that allow employees to elect the maximum-available salary reduction (rather than a specific dollar amount) and (ii) those employers that separately provided employees with “taxable” mass transit benefits for amounts paid in excess of $130 per month (i.e., amounts that were previously reported as taxable wages in 2014 but only became “erroneous” overstatements of wages because of TIPA’s retroactive mass transit provisions).
2015—Parity Eliminated for Transit Pass Benefits, But Is It Only a Temporary Elimination?
In 2012, Congress enacted a somewhat similar retroactive transit pass increase as part of the American Recovery and Reinvestment Act (ARRA). Unlike TIPA, the ARRA enacted both retroactive and prospective tax relief. Although the 113th Congress actively considered providing both retroactive and prospective relief, the TIPA provisions enacted last month restored parity only for 2014, not for 2015. The 114th Congress will revisit extending parity for 2015, but for now, such parity does not exist. Therefore, the maximum monthly transit pass exclusion has already been reduced back to $130 for 2015, while the maximum monthly parking exclusion is now $250 per month.
Although far from certain, it is anticipated that the 114th Congress will once again restore parity between mass transit and parking. Immediate proactive steps must be taken to preserve the maximum employer and employee tax savings associated with any retroactive legislation that increases the mass transit exclusion for 2015. These immediate steps include simple modifications to salary reduction elections under existing QTF plans and minor changes to transit pass distribution procedures, as well as properly worded employee communications. If these steps are not taken now, the IRS will preclude most employers and their employees from claiming the maximum employer and employee tax savings that are otherwise potentially available with retroactive parity legislation.
2016—New Requirements Imposed for Transit Passes/Smart Cards
After employers have addressed the more immediate concerns and issues relating to the mass transit parity issues for 2014 and 2015, they can more leisurely address the prospective QTF plan guidance issued by the IRS late last year. In Revenue Ruling 2014-32, the IRS provided important additional guidance on the use of smart cards, debit/credit cards, and other electronic media to provide qualified transportation benefits to employees. Rev. Rul. 2014-32 addresses various factual situations that involve the use of electronic media to provide transportation benefits.
Noting that “terminal-restricted debit cards” are now widely available, the IRS will prohibit the use of cash reimbursement arrangements for mass transit benefits after December 31, 2015. To the extent that any employer is currently using a cash reimbursement program for mass transit benefits, that program must be discontinued by the end of 2015. If not, the cash reimbursements will be fully taxable for both income tax and employment tax purposes.
Because of the potential tax savings associated with reduced taxable income and wages, retroactively restoring parity between the mass transit exclusion and the parking exclusion is certainly welcome news to many employers and employees. However, both the retroactive tax relief for 2014 and the prospective planning opportunities for 2015 contain potential pitfalls that employers should discuss with their benefits and/or tax advisers. As part of this conversation, employers should also address whether retroactive changes are required or whether they can shift responsibility to claim the retroactive increases to employees.