Guest Article

(From the May 4, 2009 issue of Deloitte's Washington Bulletin, a periodic update of legal and regulatory developments relating to Employee Benefits.)

Qualified Transportation Accounts Cannot Be Cashed Out

The IRS recently affirmed that employees are not permitted to "cash out" their qualified pre-tax transportation accounts if they terminate employment. Referencing the Treasury Regulations and citing the constructive receipt doctrine as the basis for its position, IRS explained that compensation reduction amounts for qualified transportation benefits under IRC § 132(f) are essentially not refundable. Only where the reduction election is revoked before the date the employee is currently able to receive the cash -- and before the start of the period for which the benefits will be provided -- can the employee instead receive the cash compensation. IRS Information Letters 2009-0012 & 2009-0008.

Background and IRS Analysis

Two taxpayers asked the IRS why employees who terminate employment cannot receive the balance remaining in their transit reimbursement accounts as taxable compensation. Presenting a mini-primer on the subject, the IRS first explained that qualified transportation fringe benefits -- e.g., transportation in a commuter highway vehicle, a transit pass, and qualified parking -- are excluded from gross income under IRC § 132(a)(5). The exclusion also applies to cash reimbursement for such benefits, and to the provision of such benefits under a compensation reduction agreement. Under a compensation reduction agreement, the employee elects to contribute pre-tax earnings into an account that is used to purchase the benefit. As explained by the IRS, under a compensation reduction agreement, the employee is essentially electing to convert pre-tax compensation into tax-free employer-provided transportation benefits.

The "conversion" only works, however, where the election -- to receive the non-taxable benefits instead of taxable cash compensation -- becomes irrevocable by the time the employee is able to currently receive the cash, and by the beginning of the period for which the qualified transportation fringe benefit will be provided. Only under that circumstance is the benefit deemed to be provided by the employer and entitled to the exemption. See Treasury Regulation §1.132-9 Q&A-14(c)&(d). If the employee has the right to receive the benefit in the form of cash after that time (e.g., the right to "cash out"), the employee is treated from the outset as constructively in receipt of the cash compensation and would be taxed on its full value, whether received in cash or in the form of transportation benefits.

Observations

The income exclusion for qualified transportation benefits provided through a compensation reduction election hinges on the election complying with the Treasury Regulation requirements that are designed to avoid constructive receipt. If the plan allows an employee to change the election after it should have become irrevocable -- e.g., allows the employee to "cash out" unused amounts at termination of employment -- the employee is deemed from the outset to be in constructive receipt of the taxable cash compensation and will be taxed on that amount even if it is used to purchase transportation benefits.

The information in this Washington Bulletin is general in nature only and not intended to provide advice or guidance for specific situations. If you have any questions or need additional information about articles appearing in this or previous versions of Washington Bulletin, please contact: Robert Davis 202.879.3094, Elizabeth Drigotas 202.879.4985, Mary Jones 202.378.5067, Stephen LaGarde 202.879-5608, Erinn Madden 202.572.7677, Bart Massey 202.220.2104, Mark Neilio 202.378.5046, Tom Pevarnik 202.879.5314, Sandra Rolitsky 202.220.2025, Deborah Walker 202.879.4955. Copyright 2009, Deloitte.