The Tax Cuts and Jobs Act limits an employer’s deduction for fringe benefit expenses.
Through December 31, 2017
Under pre-Act law, a taxpayer may deduct up to 50% of expenses relating to general meals and entertainment. Housing and meals provided for the convenience of the employer and on the business premises of the employer are excluded from the employee’s gross income. The employer can also take a deduction of 100% of these meals provided the employees are not highly compensated, the deduction is directly related to business meetings (ordinary and necessary), properly substantiated, and excludable because of the de-minimus value.
Various other fringe benefits provided by the employers are not included in an employee’s gross income, including transportation fringe benefits (transit passes, qualified parking, and bicycle commuting).
Effective for tax years beginning after December 31, 2017
The Tax Cuts and Jobs Act provides that:
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 new law also limits all meal deductions to 50%. This includes meals that are for the benefit of the employer, previously 100% now 50%, provided through an in-house cafeteria or on the premise of the employer. The new law also denies deductions for employee transportation fringe benefits (e.g. parking and mass transit).
However, the new law retains the exclusion of benefits from the employee’s gross pay, meaning the 50% meals and transportation is not included in the employee’s wage.
For tax years after December 31, 2025 the new law will permanently disallow the employer’s deduction for meals provided for the benefit of the employer on the employer’s premises.
In addition, no deduction is allowed for transportation expenses that are equivalent of commuting for employees (between the employee’s home and workplace), except as provided for the safety of the employee.
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.
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.
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).