IRS Provides Guidance On Use Of Smartcards, Debit Cards For Transportation Benefits.

Rev. Rul. 2006-57

[Editor's Note: In Notice 2008-74 the IRS has delayed the Effective date of this Revenue Ruling until January 1, 2010.]

ISSUE

Whether, under the facts described, employer-provided transportation benefits provided through smartcards, debit or credit cards, or other electronic media are excluded from gross income under §§ 132(a)(5) and 132(f) of the Internal Revenue Code and from wages for employment tax purposes.

FACTS

Situation 1. For 2006, Employer A provides to its employees transportation benefits in an amount not exceeding $105 each month. Transit system X provides smartcards that may be used by employers in the metropolitan area served by X as a mechanism to provide fare media for transit system X to employees. The smartcards are plastic cards containing a memory chip that stores certain information including the serial number of the card and the value of the fare media stored on the card. The amount stored as fare media on the smartcard is not authorized to be used to purchase anything other than fare media for X. A uses the smartcards as a mechanism to provide transportation benefits to its employees. A makes monthly payments to X on behalf of its employees who participate in the transportation benefit program, which X then electronically allocates to each employee's smartcard as instructed by A. A does not require its employees to substantiate their use of the smartcards.

Situation 2. For 2006, Employer B provides to its employees transportation benefits in an amount not exceeding $105 each month. Debit card provider P provides debit cards that may be used by employers to provide transportation benefits to their employees. The debit cards are restricted for use only at merchant terminals at points of sale at which only fare media for transit system Y is sold. B uses the terminal-restricted debit cards provided by P as a mechanism to provide transportation benefits to its employees. B makes monthly payments to P on behalf of its employees who participate in the transportation benefit program, which P then electronically allocates to each employee's terminal-restricted debit card as instructed by B. B does not require its employees to substantiate their use of the debit cards.

Situation 3. For 2006, Employer C provides to its employees transportation benefits in an amount not exceeding $105 each month. Debit card provider Q provides debit cards that may be used by employers as a mechanism to provide transportation benefits to their employees. Q restricts the use of the debit cards to merchants that have been assigned a merchant category code (MCC) indicating that the merchant sells fare media. The cards are restricted for use at merchants that have been assigned MCCs indicating the merchant sells fare media for some or all of the following categories: local and suburban commuter passenger transport; passenger railway; bus lines, excluding charters and tours; and transportation service (not elsewhere classified). The merchant may or may not sell other merchandise. The MCCs were developed by S, which is a debit/credit card network. S determines and updates the MCC assigned to a particular merchant based on information provided by the merchant. C uses the MCC-restricted debit cards provided by Q as a mechanism to provide transportation benefits to its employees. A voucher or similar item exchangeable only for a transit pass is not otherwise readily available for purchase by C for direct distribution to C's employees within the meaning of § 132(f)(3).

For the first month an employee participates in the transportation benefit program, the employee pays for fare media with after-tax amounts. The employee then substantiates to C the amount of fare media expenses incurred during the month following reasonable substantiation procedures implemented by C as described in § 1.132-9(b) Q/A-16(c). C then remits to Q an amount equal to the amount of substantiated fare media expenses for the prior month, which Q then electronically allocates to the debit card assigned to the employee. For subsequent months, C reimburses the employee for fare media expenses incurred by the employee by providing funds to Q to be allocated to the employee's debit card equal to the amount of fare media expenses substantiated under the following procedures (not exceeding the monthly limit provided under § 132(f)(2)). With respect to expenses for which employees seek reimbursement that were paid using the MCC-restricted debit card, C receives periodic statements providing information on the use of each debit card, which include information on the identity of the merchants at which the debit card was used, and the date and amount of the debit card transactions. In addition, for the first month the debit card was used, prior to providing reimbursement, C requires that the employee certify that the debit card was used only to purchase fare media. For subsequent months, C does not require employee certifications prior to reimbursement of recurring expenses that match expenses previously substantiated under the procedures described above as to seller and time period (e.g., for an employee who purchases a transit pass on a regular basis from the same seller). However, C requires a recertification at least annually from each employee that the debit card was used only to purchase fare media. C reviews the periodic statements in combination with the employee certifications to determine the transit pass expenses incurred by each employee through the use of the debit card and reimburses each employee for the expenses that have been substantiated by transmitting funds to Q to be allocated electronically to each employee's debit card. With respect to fare media expenses for which C's employees seek reimbursement that were not paid using the MCC-restricted debit card, the employees substantiate the amount of the fare media expenses incurred following reasonable substantiation procedures implemented by C as described in § 1.132-9(b) Q/A-16(c). For example, an employee receiving reimbursements of less than the maximum monthly excludable amount of transportation expenses may increase his or her reimbursements for future months by paying for increased fare media expenses by some method other than the use of the debit card and substantiating the additional amount using reasonable substantiation procedures as described in § 1.132-(9)(b) Q/A-16(c).

Situation 4. The facts are the same as in Situation 3, except in the following respects. Employer C provides employees with MCC-restricted debit cards as soon as they begin work. Prior to using the MCC-restricted debit cards, C's employees certify that the card will be used only to purchase transit passes. In addition, written on each debit card is the statement that the card is to be used only for transit passes, and, by using the card, the employee certifies that the card is being used only to purchase transit passes. At no time do C's employees substantiate to C the amount of fare media expenses that have been incurred.

LAW

Section 61(a)(1) of the Code provides that, except as otherwise provided in subtitle A, gross income includes compensation for services, including fees, commissions, fringe benefits, and similar items.

Section 132(a)(5) provides that any fringe benefit that is a qualified transportation fringe is excluded from gross income. Section 132(f)(1) provides that the term "qualified transportation fringe" means (1) transportation in a commuter highway vehicle between home and work, (2) any transit pass, and (3) qualified parking. The amount of the fringe benefit which may be excluded from gross income and wages for 2006 is limited to $105 per month for the aggregate of transportation in a commuter highway vehicle and transit passes, and $205 per month for qualified parking. See § 132(f)(2); Rev. Proc. 2005-70, 2005-47 I.R.B. 979, § 3.12.

Section 132(f)(5)(A) provides that a transit pass is any pass, token, farecard, voucher or similar item entitling a person to transportation (or transportation at a reduced price) if such transportation is on mass transit facilities or is provided by any person in the business of transporting persons for compensation or hire in a commuter highway vehicle. See § 132(f)(5)(B) for the definition of a commuter highway vehicle.

Section 132(f)(3) provides that a qualified transportation fringe includes a cash reimbursement by an employer to an employee for transit benefits. However, a qualified transportation fringe includes a cash reimbursement by an employer to an employee for a transit pass only if a voucher or similar item that may be exchanged only for a transit pass is not readily available for direct distribution by the employer to the employee.

Section 1.132-9(b) Q/A-16(b)(1) of the Income Tax Regulations provides that if a voucher or similar item is readily available, the requirement that a voucher or similar item be distributed in-kind by the employer is satisfied if the voucher is distributed by the employer or by another person on behalf of the employer (for example, if a transit operator credits amounts to the employee's fare card as a result of payments made to the operator by the employer).

Section 1.132-9(b) Q/A-16(b)(2) provides that a transit system voucher is an instrument that may be purchased by employers from a voucher provider that is accepted by one or more mass transit operators in an area as fare media or in exchange for fare media. Under § 1.132-9(b) Q/A-16(b)(3), a voucher provider is any person in the trade or business of selling transit system vouchers to employers, or any transit system or transit system operator that sells vouchers to employers for the purpose of direct distribution to employees.

Section 1.132-9(b) Q/A-16(b)(4) provides that a voucher or similar item is readily available for direct distribution by an employer to employees if and only if the employer can obtain it from a voucher provider that does not impose fare media charges greater than 1 percent of the average annual value of the voucher for a transit system, and does not impose other restrictions causing the voucher not to be considered readily available. See § 1.132-9(b) Q/A-16(b)(5) and (b)(6).

Section 1.132-9(b) Q/A-16(a) provides that the term qualified transportation fringe includes cash reimbursement for transportation in a commuter highway vehicle, transit passes (if permitted), and qualified parking, provided the reimbursement is made under a bona fide reimbursement arrangement. A payment made before the date an expense has been incurred or paid is not a reimbursement. In addition, a bona fide reimbursement arrangement does not include an arrangement that is dependent solely on the employee certifying in advance that the employee will incur expenses at some future date. Under § 1.132-9(b) Q/A-16(c), whether a reimbursement is made under a bona fide reimbursement arrangement depends upon the facts and circumstances. The employer must implement reasonable procedures to ensure that the amount equal to the reimbursement was incurred for transportation in a commuter highway vehicle, transit passes, or qualified parking. Section 1.132- 9(b) Q/A-16(d) provides that reasonable reimbursement procedures include the collection of receipts from employees or obtaining employee certifications in appropriate circumstances. The regulations provide that obtaining an employee's certification is a reasonable reimbursement procedure if receipts are not provided by the seller in the ordinary course of business, and if the employer has no reason to doubt the employee's certification.

Section 1.132-9(b) Q/A-18 provides that there are no employee substantiation requirements if an employer distributes a transit pass (including a voucher or similar item) in-kind to the employer's employees.

Federal Insurance Contributions Act (FICA) taxes, Federal Unemployment Tax Act (FUTA) taxes, and Federal income tax withholding are imposed on "wages." See §§ 3101, 3111, 3121(a), 3301, 3306(b), 3402, and 3401(a). Section 3121(a) defines "wages" for FICA purposes as all remuneration for employment including the cash value of all remuneration (including benefits) paid in any medium other than cash, with certain specific exceptions. Sections 3306(b) and 3401(a) define "wages" similarly for FUTA and Federal income tax withholding purposes respectively.

Section 3121(a)(20) excepts from the definition of "wages" for FICA tax purposes any benefit provided to or on behalf of an employee if, at the time such benefit is provided, it is reasonable to believe that the employee will be able to exclude such benefit from gross income under § 132. Sections 3306(b)(16) and 3401(a)(19) provide similar exclusions for FUTA and Federal income tax withholding purposes respectively.

ANALYSIS

In Situation 1, the fare media value stored on the smartcards is useable only as fare media for transit system X. Thus, the smartcard qualifies as a transit system voucher under § 1.132-9(b) Q/A- 16(b)(2) distributed in-kind by A to its employees. In addition, the amount allocated to each employee's smartcard is within the amount specified by § 132(f)(2)(A). Accordingly, the value of the fare media provided by A to its employees through the use of the smartcards is excluded from the employees' gross income as a qualified transportation fringe benefit within the meaning of § 132(a)(5) without requiring the employees to substantiate their use of the smartcards.

In Situation 2, the terminal-restricted debit card provided by B to its employees qualifies as a transit system voucher under § 1.132-9(b) Q/A-16(b)(2) because it can be used only at merchant terminals at points of sale at which only fare media for transit system Y can be purchased. In addition, the amount allocated to each employee's debit card each month is within the amount specified by § 132(f)(2)(A). Therefore, the value of the fare media provided by B to its employees through the use of the terminal-restricted debit cards is excluded from its employees' gross income as a qualified transportation fringe benefit within the meaning of § 132(a)(5) without requiring the employees to substantiate their use of the debit cards.

In Situation 3, the debit card provided by C to its employees does not qualify as a transit system voucher under § 1.132-9(b) Q/A-16(b)(2) because it is possible that a MCC-restricted debit card may be used to purchase items other than transit passes. A merchant properly classified to accept the debit card as payment may sell merchandise other than transit passes, and there is nothing in the debit card technology which prevents its use to purchase things other than transit passes.

Because a voucher or similar item exchangeable only for fare media is not readily available to C for direct distribution to its employees, § 132(f)(3) permits C to provide qualified transportation benefits in the form of cash reimbursements for transit pass expenses, but only if the reimbursements are provided under a bona fide reimbursement arrangement. With respect to expenses incurred during the first month an employee participates in the transportation benefit program, and with respect to expenses not paid using the MCC-restricted debit card, C has implemented reasonable substantiation procedures as described in § 1.132-9 Q/A-16(c). With respect to expenses paid using the MCC-restricted debit card, C receives periodic statements providing information on the purchases made with the debit card, including the identity of the seller, and the date and amount of the debit card transactions. In addition, for the first month an employee uses the MCC-restricted debit card, C requires that the employee certify that the card was used only to purchase fare media. C does not require monthly certifications with respect to recurring items if the item described in the periodic statement matches with respect to seller and time period items that have previously been substantiated as transit pass expenses. However, C requires at least an annual recertification from each employee that the debit card was used only to purchase fare media. Prior to remitting an amount to Q as reimbursement for transit pass expenses for an employee, C examines the periodic statements describing debit card transactions in combination with employee certifications to determine the transit pass expenses incurred by each employee through the use of the debit card. C provides funds to Q to be electronically allocated to the debit cards only as reimbursements for substantiated transit pass expenses that have been incurred and substantiated in this fashion. Based on the facts and circumstances, C has established a bona fide reimbursement arrangement for transit passes within the meaning of § 1.132-9 Q/A-16(c). In addition, the amount of the monthly benefit is within the amount specified by § 132(f)(2)(A). Therefore, the value of the fare media provided by C to its employees through the use of the MCC-restricted debit cards is excluded from its employees' gross income as a qualified transportation fringe benefit within the meaning of § 132(a)(5).

In Situation 4, as discussed above, the MCC-restricted debit card does not qualify as a transit system voucher under § 1.132- 9(b) Q/A-16(b)(2). Because a voucher or similar item is not otherwise readily available to C, C may provide qualified transportation fringe benefits in the form of cash reimbursements for transit passes under a bona fide reimbursement arrangement. C provides the debit cards in advance, requiring its employees to certify that they will use the cards exclusively to purchase transit passes. This arrangement does not constitute a bona fide reimbursement arrangement under § 1.132-9(b) Q/A-16(c) because it provides for advances rather than reimbursements and because it relies solely on employee certifications provided before the expense is incurred. Those certifications, standing alone, do not provide the substantiation of expenses incurred necessary for there to be a bona fide reimbursement arrangement. Because C is providing restricted-use debit cards that are not transit system vouchers, and because C is not reimbursing its employees for fare media expenses under a bona fide reimbursement arrangement, the amounts C provides to its employees through the use of the MCC-restricted debit cards are included in its employees' gross income and wages.

HOLDINGS

Situation 1. The value of the transit pass benefits provided by A to its employees through the use of the smartcards is excluded from gross income under § 132(a)(5) and from wages for employment tax purposes.

Situation 2. The value of the transit pass benefits provided by B to its employees through the use of the terminal-restricted debit card is excluded from gross income under § 132(a)(5) and from wages for employment tax purposes.

Situation 3. The value of the transit pass benefits provided by C to its employees through the use of the MCC-restricted debit card is excluded from gross income under § 132(a)(5) and from wages for employment tax purposes.

Situation 4. The amounts provided by C to its employees through the use of the MCC-restricted debit cards are not excluded from gross income under § 132(a)(5) and are wages for employment tax purposes.

EFFECTIVE DATE

This revenue ruling is effective January 1, 2008. Employers and employees may rely on this revenue ruling with respect to transactions occurring prior to January 1, 2008. As discussed in Notice 2004-46, 2004-2 C.B. 46, if a debit card qualifies as a voucher or similar item, then cash reimbursement for transit pass expenses would be precluded if such a debit card were readily available. The Treasury Department and the Internal Revenue Service will continue to review this issue, including the circumstances under which a terminal-restricted debit card may be considered not readily available because of implementation charges or other restrictions within the meaning of § 1.132-9(b) Q/A-16(b)(6) that effectively prevent the employer from obtaining the debit card for distribution to employees.

As terminal-restricted debit cards appear not to be widely used at present in areas where cash reimbursement is permissible, the Treasury Department and the Internal Revenue Service lack sufficient factual context to develop guidance at this time regarding when terminal-restricted debit cards are readily available. As use of terminal-restricted debit cards increases in cash-reimbursement areas, we intend to issue guidance clarifying under what situations the cards are considered to be readily available and thus preclude cash reimbursement for transit benefits. Until such guidance is issued, the Service will not challenge the ability of employers to provide qualified transportation fringes in the form of cash reimbursement for transit passes when the only available voucher or similar item is a terminal-restricted debit card.

DRAFTING INFORMATION

The principal authors of this revenue ruling are David R. Ford and John Richards of the Office of Associate Chief Counsel (Tax Exempt & Government Entities). For further information regarding this revenue ruling, contact John Richards at (202) 622-6040 (not a toll- free call).