IRS Debit Card Guidance Restricts Use of Cash Reimbursements

Practical Law Legal Update 9-589-4542 (Approx. 4 pages)

IRS Debit Card Guidance Restricts Use of Cash Reimbursements

by Practical Law Employee Benefits & Executive Compensation

Smartcards

The ruling first discusses whether transit system smartcards used by employers to provide employees access to the transit system are excludable from the employees' gross income. For this purpose, a smartcard is a card that:

Includes a chip that uniquely identifies the card and the value stored on the card.
Can be used either as fare media or to purchase fare media (the amount stored on the card cannot be used for any other purpose).

The employer makes monthly payments to the transit system on behalf of participating employees, and the transit system then allocates the payments to each employee's smartcard as instructed by the employer. The employer does not require employees to substantiate their use of the smartcards.

According to the IRS, because the value stored on the smartcards may be used only as fare media for the transit system, the smartcard meets the definition of a transit pass under IRC Section 132(f)(5)(A). Therefore, the value of the fare media provided by the employer through the smartcards is excluded from employees':

Gross income as a qualified transportation fringe benefit under the tax code, without requiring employees to verify their use of the smartcards (see Practice Note, Fringe Benefits under IRC Section 132: Qualified Transportation Benefits).
Wages for Federal Insurance Contributions Act (FICA), Federal Unemployment Tax Act (FUTA) and income tax withholding purposes.

Terminal-restricted Debit Cards

Addressing a similar context, the IRS concluded that the value of fare media provided through employer-provided, terminal-restricted debit cards is also excludable from the employees' gross income (and excludable from wages for FICA, FUTA and income tax withholding purposes). Under the ruling, a terminal-restricted debit card is a debit card that is restricted for use only at merchant terminal locations at which only fare media for local transit systems is sold.

MCC-restricted Debit Cards

The ruling also addresses the use of debit cards that are restricted for use only at merchants that have been assigned a merchant category code (MCC) denoting that the merchant sells fare media. (The merchants may also sell other merchandise.) Under this example, vouchers that could be exchanged only for transit passes are not otherwise available for purchase by the employer for direct distribution to its employees.

In this example, the employer provides employees with the MCC-restricted debit cards as soon as they begin their employment. Although employees must certify (before using a card) that the card will be used only to purchase fare media, employees are not required to substantiate to the employer the amount of fare media expenses incurred. Written on each debit card is a statement indicating that:

The card must be used only for fare media.
By using the card, the employee certifies that the card is being used only to purchase fare media.

According to the IRS, the amounts provided by the employer through the MCC-restricted debit cards in this example are included in employees' gross income, and are wages for FICA, FUTA and income tax withholding. This is because:

The MCC-restricted debit card does not qualify as a transit system voucher under governing regulations.
The arrangement is not a "bona fide reimbursement arrangement" (26 C.F.R. § 1.132-9(b) Q&A-16(c)) because it:
- provides for advances rather than reimbursements; and
- relies solely on employee certifications provided before the expense is incurred.
The employee certifications alone did not provide sufficient substantiation for purposes of a bona fide reimbursement arrangement.

Vanpool Delivery Charges May be Excluded

The ruling also addresses the treatment of delivery charges associated with vanpools. In this situation, the employer provides debit cards to employees that they must use to buy vanpool vouchers. The voucher provider does not sell any other merchandise, and the vouchers may be bought by an employee either online or in-person at specified locations. For vouchers purchased online, the provider imposes a reasonable and customary delivery charge, which the employee includes as a transit cost. The employee uses the debit card to pay the charge. However, the combined cost of the vanpool voucher and the associated delivery charge is not more than the governing monthly limit.

According to the IRS, the delivery charge is included as part of the transit benefit and may be excluded from employees' gross income (subject to the monthly limit).

Use of Cash Reimbursements Restricted

In the last situation, the IRS addressed the status of prior guidance (Revenue Ruling 2006-57) under which the IRS would not challenge an employer's ability to provide qualified transportation fringes in cash reimbursement form for transit passes when the only available voucher or similar item was a terminal-restricted debit card. At the time Revenue Ruling 2006-57 was issued, terminal-restricted debit cards were not widely used. In the IRS' view, however, terminal-restricted debit cares are now:

Widely used.
Generally available for purchase by employers subject to terms and costs that are comparable to other forms of electronic media.

In Revenue Ruling 2014-32, the IRS takes the position that the rule permitting employers to use cash reimbursements if the only available voucher (or similar item) is a terminal-restricted debit card is "no longer warranted". As a result, effective beginning January 1, 2016:

Employers may no longer provide qualified transportation fringe benefits in the form of cash reimbursement in geographic areas where a terminal-restricted debit card is "readily available" under governing IRS regulations.
The value of transit benefits provided by the employer to its employees through a cash reimbursement arrangement is:
- not excluded from employees' gross income; and
- is wages for employment tax purposes.

IRS Debit Card Guidance Restricts Use of Cash Reimbursements | Practical Law