Can the IRS Tax Your Organization’s Parking Lot?
By William R. Thetford, Esq. and H. Robert Showers, Esq.
Unfortunately, for now, the answer is yes! The new year is a time that many organizations begin to prepare their taxes. The IRS just released guidance on a recent controversial tax change that could significantly impact churches and nonprofit organizations as well as small businesses. The change in the tax code puts for-profit businesses and tax-exempt organizations on the same footing regarding employee parking benefits, though they are taxed in slightly different ways. Most importantly, this guidance applies to the tax year starting January 1, 2018, for which organizations are already preparing their taxes.
- What is the Tax?
The theory behind this tax is that employers who pay for their employees to have parking benefits, are essentially paying them another form of income, and thus these expenditures should be taxed in the same way. However, while this reasoning makes sense for a business in an urban area providing expensive downtown parking perks to its employees, the tax change also applies to employers (for-profit and non-profit) who merely provide their employees a parking lot with reserved or, in some cases, even unreserved spots in which their employees may park.
Unless an exemption applies, churches, non-profits, and for-profit businesses are all subject to the tax. Due to the change in the tax code, businesses must now consider parking expenses (as well as transit passes) nondeductible qualified transportation fringes when the value of the fringe benefit is over a certain amount. For 2018, that amount is $260 per month. Thus, all amounts incurred by the business for the use of its employee over $260 per month must count as income and be taxed as such.
Churches and nonprofits are similarly impacted, though for them, parking expenditures are to be reported as unrelated business taxable income ((referred to in the interim guidance as UBTI)) using Form 990-T and will be taxed at the rate of 21%.
Aside from the differences noted above, taxable parking expenses are calculated similarly for both for-profits and non-profits Expenses subject to these taxes are broad and include all expenses an employer may undertake on its parking facility, including maintenance, repairs, insurance, property taxes, snow and ice removal, leaf removal, trash removal, cleaning, landscape costs, and many others.[1] Thankfully, the tax does not include depreciation.
- How is it Calculated?
This tax is based on the IRS code found in 26 USC sections 274a(4) and 512(a)(7). However, these code sections do not provide the details of how to calculate the tax. This leaves the calculation to agency regulations. The IRS and Department of the Treasury have indicated that formal regulations on the subject are forthcoming. However, in the meantime employers are to rely on the interim guidance released by the IRS on December 10, 2018.[2]
The Interim Regulations state that until further guidance is issued “taxpayers and tax-exempt organizations that own or lease parking facilities where their employees park may use any reasonable method” to determine their tax liability under the parking benefit tax.
What are reasonable methods? To start, the IRS is explicitly clear on some theories that do not constitute a reasonable method to determine the value of the parking benefits. For instance, it is not a reasonable method for an employer to merely declare that its parking facility has no value, because the surrounding area does not have any paid parking. There may be other reasonable calculation methods, but the IRS guidance describes a specific four-step method that a church, business, or other organization is entitled rely upon as a “reasonable method” to measure its tax liability.
The preliminary step may be the most difficult: the employer must determine how much it spent in total parking costs. If the employer rents a lot or garage from a third-party, this calculation is simple. The total parking expenses constitute what the employer paid for access to that lot or garage. The entire amount paid to a third-party by a church nonprofit for employee parking will have to be added to its unrelated business taxable income and taxed at the 21% rate. For a business, the calculation is different; see Example 3 below.
This calculation is more intensive if the employer owns the building and land upon which the parking facility exists. The organization is taxed on all expenditures it paid in relation to its parking facility (including ordinary parking lots) : whether maintenance, landscaping, property taxes, snow removal, or similar expenses. The question is also complex if an employer, a church for instance, rents a facility for a single price, and the facility includes parking access in addition to the building and other aspects of the lease. The church must reasonably determine what portion of its rent is attributable to its access to the parking facility and what portion of the parking facility is deemed to go with its rented building.
Once this preliminary question is determined, an employer can rely on the up to four-step process below to determine what percentage of expenses are to be taxed.
Step 1: Calculate All Parking Spaces Reserved for Employees. If the taxpayer owns or leases a parking facility, it must identify the total number of spots, and the total number of spots which are reserved exclusively for its employees. For instance, reserved spots may be designated by signs “employee parking only” or “reserved for the senior pastor.” Separate parking facilities set apart by a barrier, with limited terms of access, or with a parking attendant will also constitute reserved parking. At a minimum, the employer will have to pay a tax on the portion of its expenses for the employee lots and reserved spaces. Thus, if 10% of its spots are reserved for employees, the employer will be taxed on at least 10% of its total parking facility expenses (considered unrelated business taxable income). If all of the spots are reserved for employees or the taxpayer rents a facility solely for its employees to use, 100% of its parking expenses will be considered unrelated business taxable income.
Step 2: Calculate the Primary Use of the Remaining Spots. If there are unreserved spots, the taxpayer must determine how many of these spots are used by employees versus the “general public.” The general public for this purpose includes customers, vendors, visitors, and for churches and religious organizations, the congregants. It also appears that students at schools will be categorized as the general public. Spots that are empty, but available to the general public, are categorized as general public, even though unused. If more than 50% of the remaining spots are used by the general public during normal business hours (or for exempt-organizations, their normal hours of operation), then these unreserved spots are exempt from the tax. When unreserved spots are exempt from the tax, the employer is only taxed on the percentage of space that is reserved for employee use.
If more than 50% of the remaining spots are used by employees, independent contractors, and partners of the employer, then the employer must go to Step 3 and 4.
Step 3: Calculate the Allowance for Reserved Nonemployee Spots. If the unreserved spots are primarily used by employees, the employer may still subtract spots that are reserved for non-employees. For instance, the employer will not have tax liability for any of the spaces reserved for visitors.
Step 4: Determine the Remaining Use and Allocate Expenses. If there are any spots that are not reserved for employee use or nonemployee use, and the unreserved spaces are not used primarily by the general public, the employer must reasonably determine the actual or estimated use of the unreserved parking spaces. For instance, if an employer leases a parking lot with 100 spaces, it is used primarily by its employees (approximately 60 each day), with no spots reserved for either employees or for nonemployees, then the employer will be taxed on 60% of its expenditures for the lot. (See Example 5 below).
For a helpful flowchart of the steps involved for the tax under the IRS Notice please click here. This flowchart was created by the accounting firm of Batts Morrison Wales & Lee and is available on their website.
- How to Become Exempt or Reduce Liability
The good news is, despite the effort required to calculate the tax liability, many churches and nonprofits will be able to adjust their practices to minimize or eliminate liability under this tax.
Many congregations with parking facilities on campus (except in the most urban areas) will have their lots used overwhelmingly by their congregants and visitors and only to a very small extent by their employees. This means that any unreserved spaces are subject to the “general public” exception and will not be taxed. These churches will retain tax liability for the portion of its parking that it reserves exclusively for its employees.
A church or nonprofit with a parking lot used primarily by the general public (more than 50%) can avoid all liability under this tax by removing all reserved employee parking.
One helpful term of the interim guidance is that the IRS has extended the period for taxpayers to adjust their parking arrangements to reduce or eliminate liability to March 31, 2019. In other words, even though these regulations apply to parking structures for the 2018 tax year, beginning January 1, 2018, a taxpayer can still reduce or eliminate reserved employee spots by March 31, 2019 and the reduced liability will apply retroactively to the entirety of 2018.
The next favorable item in the guidance is that the threshold of liability for filing Form 990-T for is $1000. IRS Form 990-T is for a nonprofit’s unrelated trade and business income. The total taxable parking expenses discussed in this article are also considered unrelated trade and business income (even though it is actually an expense, not income). Thus, if the employer would owe less than $1000 on its total unrelated trade and business income (including parking expenses), the employer does not need to file regarding this tax and would not owe anything.
- Examples
The following examples from the IRS guidance may be instructive.
Example 1: A church and school has a 500-space parking lot for which it spent $10,000 in annual maintenance during the tax year. The parking lot had no reserved visitor spaces but had 10 reserved spaces for the senior pastor and other employees. The remainder of the spaces were unmarked. During the normal hours of the tax-exempt organization on weekdays, the parking lot had approximately 50 employees parking in the unreserved spaces of the lot and the rest of the spaces were empty or used by visitors or students. During the normal hours of the organization’s weekend services, 400 congregants park in the non-reserved spots and 20 employees park in non-reserved spots.[3] The IRS four-step process would go as follows:
Step 1: Because the organization has 10 reserved spots for employees the total tax liability for its $10,000 of parking lot liability under this step is $200 ((10/500) x $10,000 = $200).
Step 2: The organization uses a reasonable method to determine that the primary use of the non-reserved areas of the parking lot is used by the general public. During weekdays 90% of the spots are used by the public (440/490) and during normal weekend activities 95% of the spots are treated as provided to the public (470/490). The expenses allocable to the unreserved spots are exempt from the tax because it satisfies the primary use test and therefore Steps 3 and 4 are unnecessary.
Thus, only $200 of the $10,000 is taxable as UBTI under 512(a)(7). As long as the organization has less than $800 in unrelated trades or business income, the organization will have less than $1000 in UBTI and will not reach the $1000 filing threshold. The organization will not be required to file a Form 990-T for this year or pay the 21% tax on any of its parking expenditures.
Example 2: However, the result is different in the following situation. A tax-exempt organization incurs $10,000 in total parking expenses for a 500-space surface parking lot which is owned by the organization. The lot has 50 spots reserved for management (or employees generally). Approximately 100 employees park in the non-reserved spots during the normal operating hours. The rest of the spots sit empty unless used by clients, visitors, and other members of the general public. [4]
Step 1: Ten percent of the total parking expenses ($1000 in this case) are subject to the tax (nondeductible for reserved employee spots) since 10% of the spaces are reserved for employees (50/500).
Step 2: The primary use of the unreserved spots is by the general public since 350 of the 450 (78%) are used by clients, visitors, other members of the general public, or are left open. Step 3 and Step 4 are unnecessary when the primary use of unreserved spots is by the general public. The result of the four-step analysis is that the $1000 in Step 1 is the extent of the taxable parking expenses. Accordingly, the exempt organization will have to add $1000 to its unrelated business taxable income. Because the taxable amount meets the $1000 threshold, the organization will be required to file Form 990-T and pay the 21% tax on $1000 of its parking expenditures.
Example 3: Employer Pays Third Party Parking Garage. For businesses the process is similar. A business pays a parking garage across the street $100 per month for each of its 10 employees to park. The $100 per employee is below the current $260 per employee, per month limit, and thus, the entire $1000 per month and $12,000 per year is excludable. There will be no tax liability on these expenditures.[5]
The result will change if the amount was changed to $300 per month. In that situation $260 would be excludable. The remaining $40 per employee per month would not be.[6] The employer must include that additional $40 per month as taxable wages to the employee and employer alike.
Example 4: Manufacturer. A manufacturer has a 500-spot parking lot used by its visitors and employees for which it expends $10,000 in a tax year. There are no spots reserved for employees. There are 25 spots reserved exclusively for nonemployee visitors. On average, 400 of the non-reserved spaces are used by employees each business day.[7]
Step 1: No parking spaces are reserved for employees, thus, there is no percentage of the total parking expenditures set aside for the tax under this step.
Step 2: The primary use of the manufacturer’s parking lot is not the general public, but the employees, even though they are not reserved.
Step 3: Twenty-five spots (5%) of the 500 total spots are reserved for non-employees. Thus, the manufacturer will need to pay the tax on up to 95% of the total parking expenditures.
Step 4: Since the primary use of the lot is not for the general public, the manufacturer must determine the employee usage of the parking lot and allocate accordingly. This would depend on how the rest of the unreserved spaces are used. See the next example for more information.
Example 5: Business Leases Adjacent Parking Lot. The following example illustrates the practical outworking of Step 4. A business leases an adjacent parking lot for its clients and employees. The business pays $10,000 in total parking expenses during the tax year. The lot contains 100 spots. No spots are reserved. On average, 60 of the spots are used by employees and the rest are available for clients and the general public.[8]
Step 1: There are no reserved employee spaces, thus there is no portion set aside for the tax on this step.
Step 2: The primary use of the lot is not for use by the general public since 60% of the spaces are used by employees.
Step 3: There are no parking spots reserved for non-employees, thus, no part of the $10,000 in parking expenditures is excluded from the tax under this step.
Step 4: This is the crucial step in such a scenario. The business must reasonably determine the use of the parking lot and allocate its expenses accordingly. Here, the business can reasonably determine that 60% of its parking expenses are subject to the tax because 60% of the spots are used by employees during usual business hours.
- Consequences
It remains to be seen how such a wide-reaching tax (potentially applying to all churches, nonprofit organizations, and businesses) will be enforced. Ministries in urban areas with more expensive parking are going to be the hardest hit by this tax, but rural or suburban organizations are not exempt. Even organizations in rural areas where free space for parking abounds will still need to make calculations and potentially pay a tax.
The likely consequence of the IRS’s notice interpreting the tax is that many churches, nonprofit and small business organizations may be removing or significantly reducing the amount of reserved employee parking to try to limit their tax liability. The easy-out under this tax is for organizations who remove all employee reserved parking (by March 31, 2019) and have parking lots used primarily by the general public. This of course, will be much easier to accomplish in a rural area, than an urban one.
This tax has proven to be controversial and many nonprofits have pushed for a repeal. However, even though there are certainly reasons to repeal or significantly reform this tax (new regulations are expected), be warned that at this point the IRS guidance controls, the tax applies, and organizations only ignore it at their own peril.
If you are concerned about your potential liability under the tax and want to take legal steps to prevent a 21% income tax on your employee parking expenditures, contact the church, nonprofit and small business attorneys at Simms Showers LLP. We are happy to assist.
Disclaimer: This memorandum is provided for general information purposes only and is not a substitute for legal advice particular to your situation. No recipients of this memo should act or refrain from acting solely on the basis of this memorandum without seeking professional legal counsel. Simms Showers LLP expressly disclaims all liability relating to actions taken or not taken based solely on the content of this memorandum. Please contact Will Thetford at wrt@simmsshowerslaw.com for legal advice that will meet your specific needs.
[1] IRS Notice 2018-99 Interim Guidance, Part B, pg 7, https://www.irs.gov/pub/irs-drop/n-18-99.pdf.
[2] IRS Issues Guidance for Determining Nondeductible Amount of Parking Fringe Expenses, IR-2018-247, Dec. 18, 2018, https://www.irs.gov/newsroom/irs-issues-guidance-for-determining-nondeductible-amount-of-parking-fringe-expenses-and-unrelated-business-taxable-income-provides-penalty-relief-to-tax-exempt-organizations
[3] IRS Notice 2018-99 Interim Guidance, https://www.irs.gov/pub/irs-drop/n-18-99.pdf. This example comes from example 9 on page 20-21 of the IRS Guidance. The Guidance contains other examples that readers may find helpful.
[4] IRS Notice 2018-99 Interim Guidance, https://www.irs.gov/pub/irs-drop/n-18-99.pdf. This example comes from example 10 on page 21-22 of the IRS Guidance.
[5] Id. at 11 (IRS Example 1).
[6] Id. (IRS Example 2).
[7] Id. at 12 (IRS Example 4)
[8] Id. at 15 (IRS Example 7)
