November 22, 2006
IRS releases additional guidance for debit cards and smartcards used for qualified transportation fringes.
In Revenue Ruling 2006-57, released November 20, the IRS provides three new ways smartcards (plastic cards containing a memory chip) and debit cards can be used to minimize many of the substantiation requirements associated with transportation expenses. The new guidance follows a trend at the IRS of increasing the ways debit cards can be used to automatically substantiate claims. As we noted here, in July 2006, the IRS provided additional guidance on the use of debit cards, credit cards, and stored value cards for use by participants in HRAs, health flexible spending accounts (health “FSAs”), and, for the first time, dependent care assistance programs (“DCAPs”).
New Guidance. Typically, qualified transportation fringe benefits must be substantiated by a third party (often the employer) when reimbursements are made. While self-substantiation of benefits is still not allowed, the IRS outlines four situations where the use of a smartcard or debit card could be used without requiring monthly substantiation of expenses.
Situation 1. In the first situation, smartcards are used as a mechanism to provide transportation benefits. The cards can only be used to pay for transit fares. An employer can make monthly payments (not exceeding $110 per month for 2007) directly to the transit system that provides the smartcards. Third party substantiation is not required because the cards can only be used to pay transportation benefits.
Situation 2. In a similar situation, an employer makes direct monthly payments to a debit card provider that provides debit cards to employees for use only at merchant terminals where transit fares are sold. Third party substantiation is not required because the cards can only be used to pay for transportation benefits.
Situation 3. In a third situation, debit cards are issued by a debit card provider that restricts the use of the cards to merchants that have been assigned a merchant category code. The merchant may sell other merchandise. For the first month, the employee pays for transportation benefits using after-tax amounts and then substantiates the claims to the employer before a reimbursement is made. For subsequent months, the employer reimburses the employee’s debit card in an amount equal to the transit fare expenses previously substantiated. Under these facts, third party substantiation is not required before each monthly reimbursement provided the employer requires certification on at least an annual basis.
Situation 4. The final situation illustrates the IRS’s continued concern with employee self-substantiation. Under the same general facts as situation 3, but this time, the employee does not take the initial step of paying for transit expenses during the first month on an after tax basis and then substantiating the claims with the employer. Instead, the employee merely certifies the card will be used only for transit purchase. No verified receipts are obtained by the employer. In this situation, the transit reimbursements received by the employee are not considered qualified transportation fringe benefits and would be included in the employee’s gross income and considered wages for employment tax purposes.
The new IRS guidance is not effective until January 1, 2008. However, the Revenue Ruling provides that employers and employees may rely on the guidance now.
If you have any questions about the foregoing items, or need assistance bringing your plans, policies, or notices into compliance, please contact us.
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The information contained in this ALERT is intended for general information purposes only and does not constitute legal advice relative to a specific situation.