Tax Article - New Guidance Explains When Smartcards Qualify As Transportation Fringe Benefits

The IRS has issued guidelines on how employer-issued “smartcards” and debit cards can qualify as nontaxable transportation fringe benefits.  Generally, employees are not required to substantiate their use of these cards.  However, the IRS nixed an arrangement that provided and relied on employee certifications before the expenses were incurred.

The new guidance covers three main situations in which smartcards or debit cards qualify as transportation fringe benefits:

1. Smartcards that can only be used for transportation and are provided by a transportation system;
2. Debit cards that are sold by merchants and can only be used to purchase transportation cards; and
3. Debit cards that are sold by merchants and can only be used to purchase fare cards or other merchandise, if the cards are used to reimburse employees for substantiated expenses.

The guidance also covers a fourth situation that, unlike the other three, does not qualify:

4. Transportation benefits provided through multi-use debit cards are taxable if the employee does not have to substantiate transportation expenses.

Smartcards and debit cards nontaxable

In Situation 1, the employer purchased smartcards from the local transit systems.  The cards could only be used to pay for transportation.  The employer made monthly payments to the transit system, which then electronically allocated amounts to each employee’s smartcard.  The employer did not require substantiation of smartcard use.

The IRS determined that the smartcard qualifies as a nontaxable transportation voucher distributed in-kind by the employer to its employees.  The amount allocated to the card is $105 per month or less, within the 2006 limit for nontaxable public transportation fringe benefits (that amount rises to $110 in 2007).  It was not necessary that the employees substantiate their use of the smartcards.

In Situation 2, the employer purchased debit cards that can be used only at merchant terminals which only provide fare media for the transit system (“terminal-restricted cards”).  The employer made monthly payments to the debit-card issuer.  The issue then allocated the amounts to each debit card.  Employees did not substantiate their use of the debit cards.

The IRS determined that the terminal-restricted debit card qualifies as a nontaxable transit system voucher because it can only be used at merchant terminals at which only transit fare cards can be purchased.  No substantiation was required.

In Situation 3, the debit card did not qualify as a transit system voucher because it could be used to purchase other items from the merchant.  Nothing in the card’s technology required that it be used for a transit pass.  However, nothing in the rules automatically prevents an employer from providing nontaxable fringe benefits through a cash reimbursement for transportation expenses as long as safeguards are present.  In situation 3, the employee was required to certify for the first month of the card’s use that it was used to provide transit cards.  Although the employer did not require monthly certifications, the employer did receive periodic statements from the debit card issuer and did require annual recertification from each employee.

The IRS determined that those procedures were enough for the employer to be considered to have established a bona fide reimbursement arrangement for transit passes under Code Sec. 132(f)(2)(A).  The benefits were nontaxable.

Taxable benefits

In Situation 4, the employer provided debit cards, similar to Situation 3.  Before using the cards, employees certified that the card would only be used for transit passes.  At no time did the employees substantiate the amount of transportation expenses incurred.

In this situation, the IRS determined that the employer’s system was not a bona fide reimbursement arrangement because it provided for advances rather than reimbursements and it relied on employee certifications before the expenses were incurred.  As a result, the amounts provided to employees through the debit cards are taxable and are treated as wages to the employees.

Effective date

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