Thousands of nonprofits that provide parking benefits for their employees are subject to a new income tax on those benefits and have only weeks to avoid or minimize that tax liability for 2018.
The 2017 Tax Act — enacted in December 2017 and effective January 1, 2018 — requires tax-exempt organizations to pay a 21 percent tax on expenses they incur to provide qualified transportation fringe benefits to their employees. The deadline for filing Form 990-T to report 2018 taxable income and pay the tax is May 15, 2019, and IRS interim guidelines give nonprofits only until March 31, 2019, to adjust employee parking arrangements to avoid or minimize taxes for 2018.
The 2017 Tax Act amended Internal Revenue Code Section 512(a) to require tax-exempt organizations to increase their unrelated business taxable income, or UBTI, by an amount paid or incurred for qualified transportation fringe benefits provided to employees. These fringe benefits include mass transit passes and employee parking arrangements.
Even nonprofit employers obligated by state law or city ordinance to provide mass transit options to employees must pay tax on expenses for this type of employee perk. For example, New York, San Francisco and Washington, D.C., require many for-profit and nonprofit employers operating in the area to offer commuter benefits to their employees. Now, complying with these ordinances can subject nonprofits to tax. Unfortunately for nonprofits, the new law became effective less than a month after its passage, leaving little time to make adjustments to avoid these additional taxes.
Many employers, including nonprofits, provide their employees nearby parking options as a convenience of employment. For example, some employers contract with third parties that own parking facilities nearby to allow employees to park at the third parties’ facilities. Before the change in law, an employer could cover the cost of the employee’s parking and the employee could exclude a certain amount of this transportation fringe benefit from income. The 2018 monthly exclusion limitation for employees was $260, meaning that if the monthly parking cost did not exceed $260, the employee did not have to recognize any income for this fringe benefit.
Under the new law, the nonprofit is subject to tax at a rate of 21 percent of the amount paid for this fringe benefit. If the actual cost for the parking arrangement per employee exceeded the $260 monthly limit in 2018, the excess continues to be treated as compensation to the employee and is not taxable to the employer.
For example, a tax-exempt organization covering the cost of monthly parking for 10 employees for all of 2018, at the $260 limit per month per employee, is deemed to have additional UBTI equal to the $31,200 paid to the third-party parking facility owner. If this organization had no other UBTI or allowable deductions from UBTI in 2018, then the amount of tax due for 2018 under the new law is $6,552.
In other instances, an employer that owns or leases a parking facility may offer free parking to its employees. A “parking facility” that would be subject to the UBTI rules would include indoor and outdoor parking garages and other structures, parking lots and other areas where employees may park at or near the place of business of a commuting location. In this case, the employer incurs costs to maintain the parking facility. These costs might include the following:
- property taxes
- snow, ice, leaf and trash removal
- parking lot attendant or security personnel expenses
- rent or lease payments
Under the new law, these expenses are considered taxable to the tax-exempt organization. The IRS has confirmed, however, that depreciation expenses associated with an employer-owned parking structure would not be subject to the UBTI rules because they are not considered a parking expense. Nonprofits may use any reasonable method to calculate the expenses associated with these parking facilities that would be subject to the UBTI rules.
IRS Notice 2018-99 provides new guidance that gives nonprofits until March 31, 2019, to retroactively reduce the amount of their parking expenses that would be considered UBTI by changing their parking arrangements. Because the expenses of parking available to the general public are not subject to this tax, one way to minimize tax is to reduce or eliminate the number of parking spaces that nonprofits reserve for their employees.
Tax-exempt organizations may be able to avoid having any UBTI if they are willing to eliminate spaces marked as reserved for employees. If a tax-exempt organization feels it must reserve certain spaces for key employees, the proportionate amount of the expenses allocated to those spaces will be included in UBTI, but the organization can avoid additional UBTI and tax due if it can demonstrate that the primary use for the non-reserved spaces of its parking facility is for the general public. As examples, the general public includes customers, clients, visitors, patients of a healthcare facility, students of an education institution and congregants of a religious organization.
Employer Pre-Tax Arrangements
If an employer does not have its own parking facility, it may offer its employees the option of bona fide cash reimbursement arrangements or compensation reduction agreements that allow employees to pay for parking pre-tax. For compensation reduction agreements, the employer withholds the cost of parking from an employee’s paycheck on a pre-tax basis and remits the funds to the owner of the parking facility on behalf of the employee. These type of arrangements are common, and as long as the amount withheld from an employee’s paycheck does not exceed the monthly limit ($260 for 2018), the employee does not have to pay income tax on the parking benefit.
One might think compensation reduction arrangements would not be covered by the changes in the new law because the employer is not out of pocket any money to cover the transportation fringe. However, at a tax conference in March 2018, an IRS official stated that the IRS would interpret this new section as imposing tax not only on employer subsidies for transportation fringe benefits, but also on the amounts employees voluntarily ask to be deducted from their paychecks and placed into pre-tax qualified plans to pay for commuting expenses. Recent IRS guidance seems to adopt this interpretation, which may cause many nonprofits to stop offering such benefits to avoid the tax.
These new rules will require tax returns from many exempt organizations that have never before filed with the IRS — including organizations that do not engage in any actual unrelated trade or business activity and organizations, such as churches, that are exempt from filing information returns. Religious organizations and many other tax-exempt employers continue to urge Congress to postpone or repeal these provisions. Despite support from individual lawmakers, however, no such legislation has passed.
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