On Dec. 9, 2020, the IRS issued final regulations that provide guidance for parking and commuting deductions under section 274. The final regulations substantially adopt the proposed regulations with minimal modifications. This alert summarizes the modifications and key takeaways for employers to consider for the expense disallowance rule.
Parking expense disallowance
The final regulations adopt the general rule and three simplified methodologies laid out in the proposed regulations for calculating the expense disallowance with minor changes. The cost per space methodology was modified to specify that the total parking spaces used by employees during peak demand should be used in the calculation of the disallowance instead of available parking spaces used by employees (which does not include reserved spaces). Allowing taxpayers additional flexibility the final regulations allow a taxpayer to use the cost per space methodology to calculate the disallowance monthly instead of just annually.
In addition, there were a number of modifications to definitions and special rules, which are described below:
General public: Clarified that parking spaces available to the general public would include parking spaces that are used to park vehicles owned by members of the general public while the vehicles await repair or service by the taxpayer (this is generally applicable to car dealerships).
Inventory/unusable spaces: Clarified that only parking spaces that would not otherwise be used for parking by the general public are included. The final regulations also added that taxpayers may use a reasonable method to determine the number of inventory/unusable spaces, which may include using the average of monthly inventory counts.
Peak demand period: Added an optional rule for use during a federally declared disaster, as defined by section 165(i)(5), allowing taxpayers to identify a typical business day for the taxable year in which the disaster occurred by reference to a typical day in that taxable year prior to the date that the taxpayer’s operations were impacted by the federally declared disaster. Alternatively, a taxpayer may choose to identify a typical business day during the month(s) of the taxable year in which the disaster occurred by reference to a typical business day during the same month(s) of the taxable year immediately preceding the taxable year in which the disaster first occurred. It is important to note this optional rule may be applied without regard to whether an election under section 165(i) is made by the taxpayer and taxpayers affected by the COVID-19 pandemic can apply this rule to taxable years ending after Dec. 31, 2019.
Mixed parking expenses: Extended the use of this special rule when using the general rule to calculate the disallowance, meaning taxpayers can now use this rule when calculating the general rule, the primary use methodology, and the cost per space methodology. The final regulations also clarify that taxpayers may pick and choose which eligible mixed parking expenses they apply the 5% rule to, meaning a taxpayer can apply both the 5% rule and any reasonable method to allocate eligible mixed parking expenses.
Geographic location: While the final regulations adopted the narrow definition of a geographic location from the proposed regulations, they clarify that a taxpayer who chooses to apply this rule must treat the aggregated parking spaces as one parking facility for purposes of determining total parking expenses.
The final regulations also made modifications to two exceptions provided in section 274(e) to the disallowance. First, when considering the exception for certain qualified transportation fringe benefits reported as compensation to employees, the taxpayer will qualify under the exception for a deduction equal to the amount included in compensation and wages, even in the event the taxpayer includes less than the proper amount in compensation and wages as required in Reg. section 1.61-21.
The other addition in the final regulations relates to the exception for expenses for transportation in a commuter highway vehicle, transit pass or parking sold to customers and pulls in a very welcome application for certain taxpayers. The final regulations allow this exception to apply in a case where in a bona fide transaction, the adequate and full consideration for qualified parking is zero. In this situation, the taxpayer bears the burden of proof but will be treated as satisfying this burden when the parking is provided in a rural, industrial or remote area in which no commercial parking is available and an individual other than an employee ordinarily would not pay to park in the parking facility. The final regulations include an example to this effect and may now provide a clarifying avenue for employers with parking in areas that is generally free to take a positon that any expenses that would otherwise be disallowed meet this exception and, therefore, are not disallowed.
The general rule for calculating the disallowance of certain transportation and commuting benefits no longer makes reference to a transportation hub and instead states the disallowance applies to travel between the employee’s residence and place of employment, regardless of whether it includes more than one mode of transportation. Further, they clarify that section 274(l) and Reg. section 1.274-14 do not apply to business expenses paid or incurred while traveling away from home. And, the final regulations clarify that an employee’s place of employment does not include temporary or occasional places of employment and the employee must have at least one regular or principal place of business.
Perhaps the most significant change to the commuting regulations is that the final regulations expand the safety exception to reference the definition of unsafe conditions as described in Reg. section 1.61-21(k)(5) instead of a narrower definition under Reg. section 1.132-5(m) provided in the proposed regulations. Regulation section 1.61-21(k)(5) states unsafe conditions exist if a reasonable person would, under the facts and circumstances, consider it unsafe for the employee to walk to or from home, or to walk to or use public transportation at the time of day the employee is commuting. Further, when determining if unsafe conditions exist, you can consider the history of crime in the geographic area surrounding the employee’s workplace or residence at the time of day the employee is commuting.
- Generally, the final regulations match the proposed regulations allowing taxpayers to calculate the disallowance of deductions for certain qualified transportation fringes using the general rule or three simplified methodologies and explain how to determine parking expenses.
- The final regulations address COVID-19 issues with differing levels of employees using parking facilities through the optional peak demand rule that can be used during a federally declared disaster and allowing flexibility to calculate the cost per space methodology disallowance per month instead of annually.
- The special rule allocating 5% of certain mixed parking expenses to the parking facility can now be used when calculating the general rule, in addition to the primary use methodology and the cost per space methodology.
- The final regulations adopted the proposed regulations narrow definition of geographic location without modification.
- The exception under section 274(e)(8) now applies to instances where in a bona fide transaction, the adequate and full consideration for qualified parking is zero. The taxpayer will be treated as satisfying the burden of proof when the parking is provided in a rural, industrial or remote area in which no commercial parking is available and an individual other than an employee ordinarily would not pay to park in the parking facility.
- The safety exception to the disallowance of certain transportation and commuting benefits now follows a broader definition of unsafe conditions under Reg. section 1.61-21(k)(5)
- The final regulations apply to taxable years beginning on or after the date, they are published in the federal register and can be relied upon for tax years ending after Dec. 31, 2019. Employers should carefully review the new regulations for comparison to previous positions taken and begin considering whether to apply the regulations for 2020.