Internal Revenue Code | Fraser Blog

Client Alert: Tax Reform Causes Some Employers to Put Transportation Plans in Park

Tax Reform Causes Some Employers to Put Transportation Plans in Park

Prior to 2018, it was commonplace for employers to provide qualified transportation fringe benefit plans, in part, to pay for or reimburse employees for costs associated with transit passes, commuter highway vehicles, carpools, or qualified parking. The benefit was not taxable to the employee and was deductible by the employer.

However, pursuant to the Tax Cuts and Jobs Act (TCJA), the employer deduction is no longer allowed effective 2018. The TCJA (formally called the “Act to provide for reconciliation pursuant to Titles II and V of the concurrent resolution on the budget for fiscal year 2018”), amended Internal Revenue Code Section 274 to deny any deduction for “the expense of any qualified transportation fringe (as defined in Code Section 132(f)) provided to an employee of the taxpayer”. See Code Section 274(a)(4). It also added Code Section 274(f) which specifically states:

No deduction shall be allowed under this chapter for any expense incurred for providing any transportation, or any payment or reimbursement, to an employee of the taxpayer in connection with travel between the employee’s residence and place of employment, except as necessary for ensuring the safety of the employee.

Moreover, Publication 15-B for 2018: Employer’s Tax Guide to Fringe Benefits confirms that no deduction is allowed for qualified transportation benefits incurred or paid after December 31, 2017, whether provided directly by the employer, through a bona fide reimbursement arrangement, or through a compensation reduction agreement. This prohibition on deductions includes any expense incurred for providing any transportation, or paying or reimbursing employees, for travel between the employees’ home and work (except for safety reasons). However, any such employer payments may be excluded from the employees’ wages.

Clearly, employers who had been subsidizing parking and transportation related expenses will no longer be able to deduct those expenses. Some commentary contemplates that by making such benefits taxable to the employee, possibly the employer would be allowed to deduct the expenses. Code Section 274(e)(2) does create an exception to Code 274(a)’s no deduction rule for expenses treated as compensation; however, this provision within Code Section 274(e) only applies to entertainment, amusement, or recreation… it was not amended to include transportation. Further guidance on this would be appreciated.

While some employers will continue to provide transportation fringe benefits to remain competitive, others are scaling back to eliminate subsidized parking and/or requiring employees to pay such expenses on a pre-tax basis through a qualifying transportation expense reimbursement arrangement.

Other Fringe Benefits

TCJA affects other fringe benefits as well. Subject to certain requirements and exceptions, effective 2018, deductions are generally eliminated for on-site premises athletic facilities; club dues and membership; entertainment, amusement and recreation; meals, food and beverages; and moving expenses.

Exempt Organizations

Finally, tax-exempt entities are also affected as they will now be taxed on the value of the transportation fringe benefits (either payment towards the benefit or the cost of an employer owned parking facility) by treating funds used to pay for these benefits as unrelated taxable income.

As mentioned above, the TCJA amended the employer deduction rules under Code Section 274 pertaining to the deduction of certain expenses for entertainment, amusement, or recreation and certain membership dues. While the elimination of the employer deduction for these expenses does not directly impact an exempt organization, the TCJA also amended Code Section 512(a) to provide that an exempt organization’s unrelated business taxable income is increased by any amount for which a deduction is not allowable under Code Section 274 and which is paid or incurred by the organization for any qualified transportation fringe (as defined in Code Section 132(f)), any parking facility used in connection with qualifying parking (as defined in Code Section 132(f)(5)(C), or any on-premises athletic facility (as defined in Code Section(j)(4)(B)). Accordingly, beginning in 2018, the amount an exempt organization pays for qualified transportation fringes, qualified parking, or on-premise athletic facilities will give rise to unrelated business taxable income.

Feel free to contact us for questions or further information on how the TCJA affects you and your business.

Elizabeth H. Latchana specializes in employee health and welfare benefits. Recognized for her outstanding legal work, in both 2018 and 2015, Beth was selected as “Lawyer of the Year” in Lansing for Employee Benefits (ERISA) Law by Best Lawyers, and in 2017 as one of the Top 30 “Women in the Law” by Michigan Lawyers Weekly. Contact her for more information on this reminder or other matters at 517.377.0826 or elatchana@fraserlawfirm.com.

Client Alert: Simple Cafeteria Plan: A Nondiscrimination Testing Alternative

Simple Cafeteria Plan: A Nondiscrimination Testing Alternative

Many small employers have historically shied away from establishing Internal Revenue Code (“Code”) section 125 cafeteria plans due to administrative and logistical issues associated with nondiscrimination testing. Specifically, many small employers’ employee population and benefit utilization makes it extremely difficult to pass the various nondiscrimination testing requirements under the Code. Further, tracking nondiscrimination testing demographics can be time consuming, costly, and just an overall daunting experience. In an attempt to provide small employers with the tax advantages associated with Code section 125 cafeteria plans without the hassle of monitoring nondiscrimination testing compliance, the Patient Protection and Affordable Care Act amended Code section 125 to permit certain eligible small employers to establish a “simple cafeteria plan”. Of interest to employers, a simple cafeteria plan (and many component benefits offered under the simple cafeteria plan) is treated by the Internal Revenue Service (“IRS”) as meeting the applicable nondiscrimination rules associated with cafeteria plans (including Code sections 125, 105(h), 129(d), and 79(d)). Thus, a simple cafeteria plan is a welcomed additional option for certain small employers that do not want to carefully monitor benefit utilization and/or who in the past have had to exclude certain highly compensated individuals from participation.

Code section 125(j) provides guidance related to compliance and administrative issues associated with simple cafeteria plans. Specifically, this Code subsection establishes (1) which employers can sponsor a simple cafeteria plan; (2) which employees must be eligible under a simple cafeteria plan; and (3) what contributions must be provided under a simple cafeteria plan:

Which Employers Can Establish a Simple Cafeteria Plan? In general, employers who employed an average of 100 or less employees on business days during either of the previous two years may establish a simple cafeteria plan. Special rules exist for newly established employers. Additionally, a “growing employer” rule exists for an employer who had been within the 100 employee threshold when it established the simple cafeteria plan under which such employer will continue to be treated as an eligible employer until the year following the first year in which it employs an average of 200 or more employees on business days.
Which Employees Must be Eligible? In general, all employees with at least 1,000 hours of service during the previous plan year must be eligible to participate in the plan. However, certain employees may be excluded (e.g., employees who have not attained age 21 before the close of the plan year; employees who have less than one year of service with the employer as of any day during the plan year; certain employees covered by collective bargaining agreements; and certain nonresident aliens working outside of the United States). And, pursuant to general cafeteria plan rules, certain individuals are categorically ineligible to participate (e.g., partners in a partnership, more than 2% S-corporation shareholders, self-employed individuals). Each employee who is eligible to participate must be able to elect any benefit available under the plan (subject to any terms and conditions that apply to all participants).
Is the Employer Required to Contribute? Qualified employees (i.e., employees who are eligible to participate in the cafeteria plan and are neither key employees under Code section 416(i) nor highly compensated employees under Code section 414(q)) must receive employer contributions in an amount equal to (1) a uniform percentage of not less than 2% of the employer’s compensation for the plan year; or (2) an amount that is not less than the lesser of 6% of the employee’s compensation for the plan year or twice the amount of the employee’s salary reductions. The employer contribution must be provided to each qualified employee, regardless of whether such employee makes any salary reduction contributions under the plan. Additional rules apply with respect to matching contributions on behalf of highly compensated employees and key employees.

To date, the IRS has not issued regulations or other guidance related to simple cafeteria plans beyond Code section 125(j). As such, to date a fair amount of flexibility exists with respect to how employers can structure their simple cafeteria plans. Nonetheless, Code section 125 cafeteria plan requirements are specific and require detailed documentation and diligence. Employers contemplating establishing a simple cafeteria plan should coordinate with their legal counsel to ensure all applicable requirements are met.

This alert serves as a general summary of lengthy and comprehensive new provisions of the Internal Revenue Code. It does not constitute legal guidance. Please contact us with any specific questions.

How Much Deference is Owed? Court of Appeals Reverses State Tax Administrator’s Use of Federal Tax Concepts

Tax is statutory. No one owes tax unless a statute imposes that liability. Thus, all tax cases begin with the applicable statute. However, tax statutes sometimes are written in general terms, requiring that important details be filled in either by reference to other authorities, administrative rules or guidance issued the state agency. Further, state tax laws frequently piggy-back on federal tax law. The typical pattern is to begin the calculation of state taxable income with federal taxable income and then to modify it by adding or subtracting items where state tax policies differ from federal tax policies. As a result, a corporation’s state taxable income can be affected by the application of the Internal Revenue Code (IRC).

State tax laws do provide for some incorporation of federal tax concepts, such as where a term used in the state taxing statute and not defined differently shall have the same meaning as when used in comparable context under the IRC. But how much deference is owed to the state’s interpretation of federal tax concepts when interpreting state tax law? The answer is not much. The Michigan Supreme Court has cautioned that when employing federal tax laws to define a state statutorily undefined term, the federal context must be comparable to the Michigan context. In the absence of a comparable context, “the Legislature intended that the word was to be [defined] according to its ordinary and primarily understood meaning,” according to the our Supreme Court.

That said, the Michigan Department of Treasury (the “Department”) generally does not consider itself bound by federal determinations respecting the application of federal tax law and believes that it is free to interpret the IRC as it sees fit. Unfortunately, this has led to problems because often the Department’s auditors do not have wide experience with or are not well-trained in federal tax principles. The same can also be generally said of the Department’s in-house legal staff. A recent decision from the Michigan Court of Appeals illustrates the misapplication of federal tax law by the state tax authorities.

On March 31, the Court of Appeals in Labelle Mgmt Inc v Dep’t of Treasury, reversed a trial court decision which found in favor of the Department’s interpretation that sufficient “indirect ownership” existed among Labelle and two brother-sister entities thus comprising a unitary business group under the Michigan Business Tax Act (MBT).

In reaching for the meaning of “indirect ownership,” the lower court looked to contextually analogous provisions of federal income tax law to supply a definition. The Court of Appeals found that this impermissibly expanded the definition of the term “unitary business group” beyond what the Legislature intended. Instead, the trial court should have relied on the normal rules of statutory construction to define indirect ownership, according to the Court of Appeals.

For a generation Michigan experimented with its business tax regime. First, in 1976 with its VAT like Single Business Tax (SBT), and then its hybrid gross receipts/income tax called the Michigan Business Tax in 2008. These schemes had little need to adhere to, or understand, federal corporate income tax concepts. Further, although the Michigan Corporate Income Tax, repealed after 1975, used the “unitary” business concept, the SBT did not and relied instead on a separate filing method. For perceived compliance reasons, the Michigan legislature adopted (or perhaps, reintroduced) the “unitary” concept when it enacted the MBT in 2008.

Under the MBT (and Michigan’s current Corporate Income Tax (CIT)), a “unitary business group” exists where one member owns or controls, either directly or indirectly, more than 50 percent of the ownership interests of the other members. Indirect ownership isn’t defined by the MBT, but it does provide that “[a] term used in this act and not defined differently shall have the same meaning as when used in comparable context in the laws of the United States relating to federal income taxes in effect for the tax year unless a different meaning is clearly required. In various administrative pronouncements, the Department instructed that “indirect ownership is generally determined by using [IRC] section 318 or analogous authority.”

Finding no “directly comparable” federal income tax provision in this case, the trial court looked to “contextually analogous” provisions of the IRC, specifically sections 957 and 958 to find that “indirect ownership” can include “constructive ownership.”

The Court of Appeals reversed, finding that the trial court erred in using the federal income tax definition of constructive ownership to define indirect ownership. The Court of Appeals stated that “the federal tax statutes and regulations are replete with examples that illustrate the proposition that indirect ownership and constructive ownership are two different concepts.” “[A]t the point the trial court acknowledged that the federal tax laws do not address a ‘comparable context,’ under Michigan law, it should have used the ordinary rules of statutory construction,” the appeals court said.

Looking at the plain and ordinary meaning of indirect ownership, the Court of Appeals reasoned that it means “ownership through an intermediary, not ownership by operation of legal fiction,” as is the case with constructive ownership as the Department argued. Finding otherwise would expand the statute “beyond the meaning intended by the Legislature,” Put bluntly, if the Legislature had intended the constructive ownership rules of the IRC to apply, they would have said so. Finding that none of the entities involved owned more than 50 percent of any other, through an intermediary or otherwise, the Court of Appeals concluded that the taxpayer was entitled to summary judgment and reversed.

The takeaway here is that one should not rely on administrative interpretive positions of the Department were they apply federal tax concepts, nor should one assume that state tax auditors will understand and correctly apply federal tax principles. It may be necessary to call upon a company’s federal tax advisors to explain these principles, and it will likely be necessary to talk to senior people in the Department, who are more likely to be knowledgeable about federal tax rules than are the auditors.

Fraser Trebilcock attorney Paul V. McCord has more than 20 years of tax litigation experience, including serving as a clerk on the U.S. Tax Court and as a judge of the Michigan Tax Tribunal. Paul has represented clients before the IRS, Michigan Department of Treasury, other state revenue departments and local units of government. He can be contacted at 517.377.0861 or pmccord@fraserlawfirm.com.