After several tax reform proposals, the final version of the Tax Cuts and Jobs Act not only comes with an unwieldy name (officially, “An Act to Provide for Reconciliation Pursuant to Titles II and V of the Concurrent Resolution on the Budget for Fiscal Year 2018) but also a host of important changes to the tax treatment of employer-sponsored transportation benefit programs. In addition, the new law also restricts an employer’s ability to deduct many common business expenses, such as meals, entertainment and employee moving expense reimbursements. The Act also creates a new tax credit for employers who provide paid family and medical leave to their employees. The following summary highlights some of the new rules implemented by the Act.
Qualified Transportation Fringe Benefits
The Act substantially alters the tax treatment associated with employer-sponsored qualified transportation fringe benefit programs, such as programs where employees are provided allowances for parking or other transportation to work. First and foremost, the Act repeals the employer’s deduction for most “expenses” associated with qualified transportation programs. (The Act preserves the employer’s deduction for:  expenses necessary for the employee’s safety, and  reimbursement of travel expenses incurred by the employee for travel between his/her home and business.)
The Act is arguably broad enough to mean that the limitation on the employer’s deduction on transportation fringe “expenses” will prevent employers from deducting the wages paid to employees who choose to contribute pre-tax dollars to a qualified transportation fringe benefit program. While the IRS has not yet issued guidance on how to interpret the word “expenses,” this could be a negative development for taxable employers that could lose a deduction opportunity. In addition, the effect of this reading of the Act could be quite detrimental to tax-exempt entities. Generally speaking, non-deductible transportation benefit expenses will cause tax-exempt entities to incur unrelated business taxable income (UBTI). If a tax-exempt entity provides an opportunity for employees to pay transportation expenses on a pre-tax basis, the entity may inadvertently trigger UBTI, which could be a significant issue. Further complicating this issue are the local laws in New York City, Washington, DC, and the San Francisco Bay area that require certain employers to maintain qualified transportation fringe benefit programs under Code Section 132(f). Therefore, it will not be easy for certain employers to simply discontinue transportation fringe programs in order to avoid UBTI. Until further guidance is issued, tax-exempt entities should work with legal counsel and tax advisors to evaluate their potential UBTI exposure and options for providing transportation fringe program alternatives.
The good news is that the Act does not materially alter the employee’s tax treatment of employer-sponsored transportation benefits. Specifically, the new law does not restrict the employee’s ability to exclude a portion of the transportation fringes they receive (other than qualified bicycle commuting expenses, which cannot be excluded again until 2026). Further, employees are still permitted to set aside money on a pre-tax basis to pay for certain qualified transportation expenses if the employer maintains such a program.
Qualified Moving Expense Reimbursements
The Act discontinues the favorable tax treatment for employer reimbursements of an employee’s moving expenses. In addition, the Act prohibits employees from deducting moving expenses that were not paid or reimbursed by an employer. This means that no tax benefits will be available with respect to an employee’s relocation for work, regardless of whether the employer or employee bears the cost. The changes affect expenses incurred on or after January 1, 2018.
Both the exclusion and deduction are preserved only for active duty members of the military who move pursuant to a military order. Additionally, the favorable tax treatment for moving expenses will revert to its pre-2018 form beginning in 2026.
Employee Achievement Awards
Prior to tax reform, the Code allowed employers to provide different types of employee achievement awards on a tax-free basis. This income exclusion applied to the value of any “tangible personal property” given to an employee as an award for either length of service or safety achievement—e.g., the traditional gold watch award for service. The Act retains this exclusion and codifies limitations that were previously found only in proposed Treasury regulations. Under the Act, the following categories of employee awards are not considered tangible personal property: cash, cash equivalents, gift certificates (except when employees can only choose from a limited array of items pre-selected or pre-approved by the employer) or other intangible property such as vacations, meals, lodging, tickets to theater or sporting events, stocks, bonds and other securities. The amount of the exclusion is $1,600 per employee annually for “qualified plan awards” (defined as those awarded as part of an established written plan or program of the employer which does not discriminate in favor of highly compensated employees) or $400 for awards that are not “qualified plan awards.”
New Tax Credit for Employers Providing Paid Family and Medical Leave
The Act adds new Section 45S to the federal tax code to incentivize the use of paid family and medical leave. Section 45S allows employers to claim a business tax credit for a portion of the wages paid during family and medical leave. To qualify, employers must have a written program providing all qualifying full-time employees at least two weeks annual paid family and medical leave. Importantly, part-time employees must be provided a commensurate amount of leave on a pro rata basis. Eligible employers who pay at least 50 percent of an employee’s regular wages during the leave can claim a credit of 12.5 percent of the wages paid for up to 12 weeks of family and medical leave per year. The credit is increased by 0.25 percentage points, up to a maximum of 25 percent, for each percentage point by which the rate of payment exceeds 50 percent. The new credit is effective beginning January 1, 2018.
Meals and Entertainment
Effective January 1, 2018, the Act completely eliminates an employer’s tax deduction for most entertainment, amusement and recreation expenses—even if those expenses are related to the employer’s business (such as hosting a client at a sporting event). The Act preserves the employer’s right to deduct 50 percent of certain non-entertainment meal expenses, such as expenses incurred by an employee on business-related travel. The Act further expands the 50 percent deduction to include food and beverages provided to employees through an eating facility at or near the employer’s business premises, so long as the expense would be excluded from the employee’s income as a de minimis fringe benefit under Code Section 132. Beginning in 2026, employers will no longer be able to deduct the expenses of operating such a facility, including the costs of the meals furnished for the convenience of the employer.
Affordable Care Act Individual Mandate
The Act also repeals the controversial “individual mandate” portion of the Affordable Care Act effective as of January 1, 2019. (The penalty remains in effect for 2017 and 2018.) This change does not directly impact employer-sponsored medical plans, nor does it impact the “employer mandate” portion of the Affordable Care Act. Employers should not expect to see significant changes as a result of the individual mandate’s repeal, other than a slight decline in younger, lower-paid workers electing coverage in 2019.
Changes Proposed, but Not Enacted
Earlier versions of the tax reform legislation proposed changing or eliminating the tax-favored treatment of educational assistance programs, dependent care assistance programs, adoption assistance programs, employer-provided childcare, and employer provided housing benefits. These proposed changes, however, did not appear in the final version of the enacted legislation.
Given the short notice of many changes under the newly enacted tax reform legislation, employers should promptly and carefully review their employee benefit programs to ensure they are providing benefits in the most tax-efficient way possible. Because the changes in the Act also impact the deductibility of expenses, employers should examine their reimbursement policies to determine whether changes are warranted. In addition, tax-exempt organizations should consult their advisors to determine whether continuing to maintain a fringe benefit program might inadvertently trigger UBTI liability. In the meantime, we expect to see clarifying guidance and regulations from the IRS on many of these new tax rules.
McDermott’s tax reform task force is monitoring legislative and regulatory developments closely. If you have any questions regarding the implications of the recent tax reform on your employee benefits programs, please reach out to your regular McDermott lawyer or one of the authors.