Tax Treatment of Transportation Fringe Benefits

July 22, 2019

Taxing transportation fringe benefits was one of many changes to the tax code arising from the Tax Cuts and Jobs Act (TCJA). However, most of these benefits are still taxed differently than wages, making the tax code more complicated and favoring some forms of compensation over others. Ideally the tax code should treat all compensation the same, meaning that fringe benefits should be deductible for employers and taxable for employees to ensure neutrality, raise revenue, and simplify the tax code.

Before the 2017 tax reform law, transportation fringe benefits were generally excluded from worker income for both payroll and income tax purposes and deductible from the employer’s taxable income up to certain amounts. The main exempted transportation fringe benefits are called Qualified Transportation Fringe benefits (QTF) and include things like commuter highway vehicle rides; transit passes for metro, rail, bus, or ferry; parking in business premises; and biking expenses.

This tax treatment meant QTFs went completely untaxed, reducing federal revenue and encouraging businesses to provide their employees with more compensation in the form of QTFs instead of wages. Firms did this in order to reduce the overall tax burden on compensation they provided to employees.

But starting in 2018, the TCJA suspended the $20 per month, per employee exclusion for biking benefits, and retained the deduction for employers until 2026. This change made the tax code neutral by treating biking benefits just like wage income.

The TCJA also narrowed the tax gap between wages and other QTFs, but it did so in a way that arguably increased complexity for businesses. It prohibited businesses from deducting the cost of QTFs and allowed employees to continue excluding these QTFs from their income.

Ideally, the tax code would treat all QTFs as deductible for the employer but taxable for the employee, just like regular wages. Instead, the TCJA’s changes now require employers to treat one set of QTFs as deductible, but another set as nondeductible, meaning employers still have to account for these differences in order to comply with the tax code. Additionally, taxpayers still have to sort which QTFs they can exclude from their income, and which they have to pay taxes on. As a consequence, employers now face more complexity from this provision than under previous law.

Making some QTFs nondeductible for businesses also means that the amount employers pay their employees in QTFs, such as commuter vehicle, transit, and parking benefits, would be included in their profits and taxed at the employer’s tax rate: 21 percent for corporations and up to 37 percent for pass-through businesses such as partnerships, LLCs, S corporations, and sole proprietorships which pay taxes through their owners under the individual income tax.

When compared to the 38.5 percent average marginal tax rate on wages, corporations still have an incentive to provide more compensation in the form of nondeductible QTFs compared to wages. Most pass-through businesses have almost no tax incentive to provide QTFs because their federal marginal tax rate of up to 37 percent is nearly the same as the average marginal tax rate on wages.

Additionally, maintaining any exclusion of benefits from income will benefit higher-income workers more than lower-income workers, since the U.S. has a progressive tax system.

Ideally, the tax code should treat all QTFs as it now treats biking benefits: deductible for employers and taxable for employees. This would both eliminate the subsidy for transportation fringe benefits that existed before the TCJA, raise revenue, and make the tax code simpler for taxpayers.

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