Seyfarth Synopsis: Many employers maintain a tax-preferred transportation fringe benefit plan to provide tax-free transit benefits to employees. Under such plans, the benefit is often distributed in the form of an electronic voucher or payment card. However, if the electronic payment card malfunctions after it is received, cash reimbursements for transit expenses will be taxable.
The Office of Chief Counsel of the IRS has released a memorandum addressing the taxation of cash reimbursements for employee transportation benefits when an employer-provided transit card malfunctions. In general, transit passes provided by an employer to employees are qualified transportation fringe benefits excludable from gross income (up to $270 per month for 2020). A "transit pass" is any pass, token, farecard, voucher, or similar item (such as a smartcard or terminal restricted debit card) that entitles a person to transportation on mass transit facilities.
Cash reimbursements by an employer for a transit pass are nontaxable only if a voucher (or similar item that may be exchanged for a transit pass) is not "readily available" for distribution in-kind to the employee. When available, employers must distribute vouchers or electronic payment cards that qualify as vouchers instead. The IRS has recognized certain nonfinancial restrictions that effectively prevent the employer from obtaining vouchers or electronic payment cards (e.g., advance purchase requirements, purchase quantity requirements, and limits on denominations of available vouchers) as restrictions that prevent vouchers or the cards from being readily available. Under that guidance, if an employer distributes a transit card that is not functioning, the employer would reasonably assume that such malfunction would be considered a nonfinancial restriction that prevents the card from being readily available and provide nontaxable cash reimbursements to the employee for payment of eligible expenses.
But wait, not so fast. The IRS memorandum clarifies that once an employer has distributed a functioning transit pass or card to employees, the benefit is considered provided, meaning it is no longer possible to treat the benefit as not readily available for distribution to employees. If a card later malfunctions, even if the malfunction is not caused by the employer or employee (e.g., the card's chip stops working or the system reading the card malfunctions), the card is still treated as readily available to employees. "Since the employee has a valid card, it would be the transportation system's responsibility to honor the card and address possible technical malfunctions." As a result, any cash reimbursement issued by the employer as a result of such malfunction is a taxable benefit.
The takeaway from this guidance appears to be that employers should be careful not to act too quickly, and that cash issued to an employee as a result of the malfunction of a transit voucher, pass or card after being issued to the employee, will be a taxable benefit. So, as the saying goes, "no good deed goes unpunished." Or untaxed!
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