UBTI Update – Taxable Transportation Benefits

UBTI Update: Taxable Transportation Benefits under IRC § 512(a)(7)

March 16, 2018

This provision of the Tax Cuts and Jobs Act addressing qualified transportation fringe benefits (“QTB’s) can be best understood as a corollary to another change that impacts for-profit businesses. Effective January 1, 2018, for-profit businesses are no longer allowed a tax deduction for providing QTB’s to employees. Eliminating tax deductions was a way for Congress to offset some of the reduced revenue from lower tax rates.

Tax-exempt organizations generally do not pay income tax, so the disallowed QTB deductions would not have affected them. Before 2018, tax-exempt organizations were only subject to income tax if they generated income, either through investments, active businesses or debt financing, unrelated to the organization’s tax-exempt purpose; hence the term Unrelated Business Taxable Income.  Ultimately, Congress decided that tax-exempt employers should incur a tax liability, equivalent to the loss of the deduction for for-profit employers, in the form of UBTI on the value of QTB’s provided to employees. 

The resulting legislation is IRC §512(a)(7), which reads as follows:

Increase in unrelated business taxable income by disallowed fringe.

Unrelated business taxable income of an organization shall be increased by any amount for which a deduction is not allowable under this chapter by reason of section 274 and which is paid or incurred by such organization for any qualified transportation fringe (as defined in section 132(f)), any parking facility used in connection with qualified parking (as defined in section 132(f)(5)(C)), or any on-premises athletic facility (as defined in section 132(j)(4)(B)). The preceding sentence shall not apply to the extent the amount paid or incurred is directly connected with an unrelated trade or business which is regularly carried on by the organization. The Secretary shall issue such regulations or other guidance as may be necessary or appropriate to carry out the purposes of this paragraph, including regulations or other guidance providing for the appropriate allocation of depreciation and other costs with respect to facilities used for parking or for on-premises athletic facilities.

512(a)(7) is unusual in that, unlike any other provision of §512, this subsection creates taxable income out of expenses paid. These otherwise non-taxable benefits provided to reduce the costs of parking and mass transit for employees could now become the only source of unrelated business income for many organizations. It is also worth noting that §513(a)(2) provides that an unrelated trade or business does not include any activity carried on by a §501(c)(3) organization for the convenience of its employees. Under the new regulations, providing transportation benefits to employees, though not a trade or business, creates UBTI even though it is provided for the convenience of employees.

All this begs the question, if it’s not business income and it’s not unrelated, then how is it unrelated business income? We will have to wait for further guidance from the IRS and Treasury to help make sense of these seeming contradictions.

Practical Considerations – Questions and Answers

1. What is a qualified transportation fringe benefit?

Qualified Transportation Fringe Benefits generally include

1. Transportation in a commuter highway vehicle
2. Any transit pass
3. Qualified parking
4. Bicycle reimbursement
5. On-site athletic facilities

2. If a tax-exempt employer provides any of these QTB’s, which of them generate UBTI?

Only the first 3 of the 5 benefits listed above generate UBTI: transportation in a commuter highway vehicle, transit passes and qualified parking.

3. What is qualified parking?

The term “qualified parking” means parking provided to an employee either on or near the business premises of the employer or on or near a location from which the employee commutes to work by transportation in a commuter highway vehicle, or by carpool. Such term does not include any parking on or near property used by the employee for residential purposes.[1]

4. Are QTB’s now taxable as wages to employees?

No. Except for bicycle reimbursements, these benefits are not taxable as wages as long as they are under the monthly thresholds.

5. What are the thresholds for QTB’s to remain nontaxable to employees?

The threshold to remain non-taxable to employees is $260 per month for 2018

6. How is qualified parking valued and could UBTI apply if the organization owns or leases a parking lot or spaces directly?

The value of parking is equal to the cost that an individual would incur in an arm’s-length transaction for a space in the same lot or a comparable lot in the same general location under the same or similar circumstances.[2] And yes, if an employer provides free parking to employees who would otherwise have to pay for similar parking, then UBTI may apply to the value of such parking.

7. If QTB’s are currently provided by a tax-exempt organization, how can benefits/compensation be altered to avoid UBTI?

If an organization discontinues providing QTB’s, it will no longer be subject to UBTI for those expenses incurred. If the value of the formerly provided benefits were instead added to an employee’s wages as cash compensation, the employee’s gross taxable income would increase. The employer and employee would pay FICA tax on those increased wages and the employee would have greater federal income tax withheld. The employee could then pay their own transportation costs, but those expenses would not be deductible for the employee if incurred while commuting to their normal place of employment.

8. Can a salary reduction plan be used, allowing employees to elect whether to receive compensation or QTB’s, and does this allow the employer to treat the payment as compensation rather than payment of a QTB?

A salary reduction plan may be used subject to the rules under Treas. Reg. 1.132-9. The AICPA posed this question to the IRS in January, requesting guidance. A strict reading of Treas. Reg. 1.132-9 would lead one to conclude that the employer is still providing a QTB to an employee who elects to receive the QTB for a given month instead of cash. Unless further guidance explains differently, we think it is reasonable to conclude that if cash compensation is elected, the employer incurs compensation expense and the employee includes this compensation in taxable gross wages. If the employee elects to receive the QTB as a non-taxable benefit, then the employer will have provided a QTB subject to UBTI.

9. Are there any exceptions when providing QTB’s might not be subject to UBTI under §512(a)(7)?

Sec. 274(l)(1) only allows a deduction for QTB’s when “necessary for ensuring the safety of the employee.” So if a tax-exempt employer provided QTB’s for an employee’s safety, then that payment would not be subject to UBTI. §512(a)(7) also provides an exception if the QTB was paid as part of another trade or business activity.

10. If an organization has a fiscal year ending June 30, 2018, when would §512(a)(7) apply to QTB’s provided by that organization?

The organization is subject to UBTI for QTB’s it provides employees after December 31, 2017. In this case, the organization would have 6 months of benefits subject to UBTI. If the value of those benefits exceeds $1,000, the organization is required to file Form 990-T for its 2017 tax year ending June 30, 2018.

11. Will my organization need to pay estimated tax installments and what are the consequences for not doing so?

If an organization provides QTB’s valued in excess of $1,000 it must file Form 990-T. If the tax liability on the 990-T is more than $500 and estimated tax payments were not made, the organization generally will be subject to penalty for underpayment of estimated tax. The current underpayment rate is 4% which would be multiplied by the amount and period of the underpayment. 990-T filers can pay a safe harbor estimated tax equal to the prior year’s 990-T tax unless their net UBTI was $1 million or more in any of the prior 3 years, in which case they must pay estimated tax based on current year income. If an organization had no 990-T tax liability in the prior year, it also has no safe harbor and must pay estimated tax based on current year income.  

12. If an organization incurs expenses in complying with IRC §512(a)(7), is a deduction allowable to offset UBTI?

The answer is not clear. The provision describes that UBTI is increased by the value of the QTB’s. The implication might be that after net UBTI is calculated, these benefits would be added to the total and no further deduction would be allowable.

 

[1] IRC §132(f)(5)(C)

[2] Treas. Reg. 1.61-21(b)(2)