Fringe Benefits: Navigating the New Entertainment Expense and Transportation Rules
As an employer, you are well aware of the difficulties businesses are facing in implementing the new tax statute known as the Tax Cuts and Jobs Act (“TCJA”). To lower tax rates, especially for businesses, the TCJA eliminates certain deductions so federal revenues do not decline too much. January 1, 2018 marked the change to tax deduction rules on two common business expenses: entertainment expenses and transportation fringe benefits. While the TCJA legislative changes are not detailed, the effects are significant. With the loss of employer deductions, your business should consider behavior adjustments to account for the increased cost of the formerly deductible expenses.
The following guide to the fringe benefit changes can help you determine what steps are best for your business.
Entertainment expenses — no longer deductible
Under TCJA, entertainment expenses incurred on or after January 1, 2018, are no longer deductible. Formerly, entertainment expenses were 50% deductible if they were directly related to, or associated with, conducting business. Detailed regulations further defined when this occurred.
Over the years, businesses liberally interpreted the rules to claim deductions for entertainment costs. In turn, Congress added additional expense limits, focusing on meals, spousal travel and conventions outside North America. Beginning in 2018, the new law makes all entertainment expenses nondeductible.
Tax-exempt organizations are affected by these rule changes to the extent entertainment costs are associated with unrelated business income.
One of the most controversial areas that is impacted by this new limit on deductions is business meals. Clarification and examples are still needed to confirm whether meals with current and prospective clients and other business relationships are considered nondeductible entertainment expenses or 50% deductible meals associated with operating the business. It may seem obvious to a business owner that when you share a restaurant meal that is not extravagant with a current client or customer during which both non-business and business topics are discussed, that the cost should be 50% deductible. Just as business meals with employees of the same firm are 50% deductible or meals for employees traveling for business.
However, what if the person joining you is not a current client, but another professional or a prospective client? Is this entertainment or a necessary part of the business operation? Should the costs be considered differently for tax purposes? Current IRS guidance, which has not been updated since the TCJA was enacted appears to make no distinction between entertainment and non-entertainment meals. That is, the IRS views meals as entertainment when you provide a customer or client a meal whether along with entertainment or by itself, and includes the cost of the food, beverages, taxes and tips for the meal.
To be fair, this distinction did not matter until the TCJA changes happened. Prior to the TCJA, meals and entertainment expenses were both limited to 50%. Now it’s important to know which is which. One deduction is 100% disallowed and the other remains 50% allowed.
The TCJA conference committee report describes both the House bill and Senate amendment, states that businesses may still generally deduct 50% of the food and beverage expenses associated with operating their business, such as meals consumed by employees on work travel. This example of food and beverage expense helps give light to an intent that business meals not incurred while traveling may be treated similarly.
However, there is still a need for clarification around this subject. While we wait for guidance, you may want to assume meal expenses are non-deductible for conservative tax planning.
Qualified transportation fringe benefits
In the early 1990s, Congress wanted to provide incentives to use mass transit and limit the income and employment tax exclusion for parking employers provide to employees. To do that, qualified transportation fringe benefits were created. This benefit was enhanced in 1997, when Congress provided that an employee could choose pre-tax salary reduction to pay for mass transit commuting and parking costs. The use of employer-provided parking exploded as a tax-free fringe benefit.
With enactment of the TCJA, Congress decided to leave in place the employee’s exclusion from income for the transportation/parking benefit. Instead, the new law eliminates the employer’s business expense deductions associated with providing this benefit. Tax-exempt and governmental organization employers were also impacted by TCJA. As elimination of a tax deduction is not usually meaningful for these organizations, Congress made their costs of providing transportation and parking for employees subject to unrelated business income tax. That’s right—an expense item is taxed as income!
Employer-provided parking is a qualified transportation fringe benefit. As such, there are disallowed costs. What costs are no longer deductible? Look for lease costs or ownership costs and administrative support costs to provide the parking benefit. If amounts are not separately stated, employers will need to make a good-faith allocation of these costs, taking into account the relative fair market value (FMV) of the various items included in the lease or ownership costs.
For example, a parking lot owned by your business may have snow removal, depreciation, maintenance, security and similar expenses. There may be costs to purchase, distribute and replace transit passes for your employees. Companies will need to aggregate these costs and, if the costs relate to employee and nonemployee use, allocate the costs between employees’ use and others’ use. Consider a conservative approach to accumulating and identifying nondeductible costs for 2018 tax planning.
Value of parking benefit
Because your employees exclude from their income the value of the parking benefit provided, and your disallowed employer deduction is the cost of providing that parking benefit, you may wonder whether a value of $0 for qualified parking might eliminate the transportation fringe benefit, since you are not providing anything of value.
IRS Notice 94-3 provides an example of a rural industrial facility where no commercial parking is available. While the employer provides parking free of charge, the value of the parking would be $0 because nonemployees would not normally pay for parking at this location. In this example, because the parking has a $0 market value, no qualified transportation fringe benefit exists. If there is no qualified transportation fringe benefit, the TCJA rule limiting employer deductions for qualified transportation fringes might not apply.
This previously issued guidance applies to the employees’ income exclusion rule for qualified transportation fringe benefits and may not extend to this new employer disallowed deduction rule. The TCJA deduction limitation focuses on the costs incurred and not the employee’s value received. So, even if the $0 value rule applies, businesses may still have costs disallowed. Until IRS guidance is released on this question, we suggest a conservative approach to tax planning, and assume there are nondeductible costs to identify and allocate to employee benefits.
With these new fringe benefit changes, your business will need guidance and a practical approach to navigate this new legislation. Our dedicated team of tax experts at Cherry Bekaert can explain the details of these changes specific to your situation, and help you determine which actions are best for your business.