A Permanent “Path” to Maximize Tax Savings: New Legislation Retroactively Increases the Exclusion for Mass Transit Benefits
In late December of last year, US President Barack Obama signed the Protecting Americans from Tax Hikes (PATH) Act of 2015, which, among other things, retroactively increases the maximum monthly exclusion from income and wages for employer-provided mass transit expenses in 2015 to the same level as the exclusion for qualified parking expenses. The PATH Act also provides parity on a permanent basis for tax-favored commuter transit and parking benefits under qualified transportation fringe (QTF) benefit programs in 2016 and beyond.
Although seemingly at odds with the desire of the US Congress to increase the use of mass transit, the maximum monthly mass transit benefit has historically been much lower than the monthly qualified parking exclusion. While Congress has in prior years created parity between these two types of QTF benefits—by raising the monthly mass transit exclusion to the same level as the parking exclusion—such parity was never permanent. The PATH Act ends this trend by providing for a retroactive adjustment of the 2015 monthly limit on an employee’s pretax contributions for mass transit expenses from $130 to $250 (the 2015 monthly limit applicable for parking expenses). As a result, transit benefits in excess of $130 per month (but less than $250 per month) are retroactively excludable in 2015 for a maximum retroactive wage reduction of $1,440 per employee. This reclassification will take the form of a year-end adjustment to be reflected on the employee’s 2015 Form W-2, consistent with recently issued guidance from the Internal Revenue Service (IRS) in response to the PATH Act. This new legislation also raises the pretax limit on both mass transit and parking expenses incurred in 2016 to $255 per month (to be indexed for inflation in future years).
Although the PATH Act provides tax relief for mass transit benefits previously elected in 2015, it does not allow employees to make retroactive transit benefit elections for 2015. Rather, it changes the tax treatment of the 2015 salary reductions and disbursements that actually occurred in 2015. As such, the PATH Act’s retroactive parity provisions will likely only affect two types of employers for 2015:
- Employers with QTF plans that allow employees to elect the maximum-available salary reduction (rather than a specific dollar amount)
- Employers that separately provided employees with “taxable” mass transit benefits for amounts paid in excess of $130 per month (i.e., amounts that were previously reported as taxable wages in 2015 but only became “erroneous” overstatements of wages because of the PATH Act’s retroactive mass transit provisions).
For some employees who commute using mass transit, the changes implemented by the PATH Act potentially mean hundreds of dollars in income tax and Federal Insurance Contributions Act (FICA) tax savings and refunds for 2015. For employers, this may also include significant FICA tax savings for last year.
Consistent with action taken by the IRS in prior years (for example, IRS Notice 2015-2 issued January 9, 2015 in response to the enactment of the Tax Increase Prevention Act of 2014 (TIPA)), the IRS issued Notice 2016-6 on January 11, 2016 in response to the PATH Act’s enactment. This new guidance addresses employers’ questions regarding the retroactive application of the increased mass transit exclusion for 2015. The new guidance includes special administrative relief for filing Form 941 (Employer’s Quarterly Federal Tax Return) for the fourth quarter of 2015, simplified correction procedures to correct excess employer/employee FICA taxes, and Form W-2 information reporting and correction procedures to accurately reflect the adjusted taxable wages and FICA/federal income tax withholding amounts. The new guidance also clarifies that the retroactive exclusion applies whether the transit benefits were provided by employer funds or through employee salary reduction arrangements. Going forward, simple modifications to salary reduction elections under existing QTF plans and properly worded employee communications will be needed. We will continue to monitor developments in this area in the upcoming weeks and update our blog upon the issuance of any additional IRS guidance in response to the enactment of the PATH Act.
Finally, as highlighted in our 2015 Lawflash “Immediate Action Required to Maximize Tax Savings for Mass Transit,” the IRS issued QTF plan guidance in late 2014 on the use of smart cards, debit/credit cards, and other electronic media to provide QTF benefits to employees. Revenue Ruling 2014-32 addresses various situations involving the use of electronic media to provide transportation benefits. Since “terminal-restricted debit cards” are now widely available, the IRS is prohibiting the use of cash reimbursement arrangements for mass transit benefits after December 31, 2015. To the extent that any employer still uses a cash reimbursement program for mass transit benefits, that program was to be discontinued by the end of 2015. If not, the cash reimbursements will be fully taxable for both income tax and employment tax purposes.