By David Marino
The federal government has slipped in a new tax increase on businesses that is going to catch financial executives unprepared and in conflict with their auditors in how to account for it. As of this year, parking expenses for employees, including an amount allocated to parking if not broken out in rent/lease payments, are nondeductible for tax purposes. The applicable tax code section is US Code Sec. 274(a)(4). The IRS clarifies in Notice 2018-99 that parking expenses are included as part of the nondeductible transportation expenses. This is the case even when employers or employees do not pay for parking as a separate expense from the landlord or other third party. The calculation can get quite technical, so here is more background on the IRS stipulations:
– US Code Sec. 274 (a) (4) states: “No deduction shall be allowed under this chapter for the expense of any qualified transportation fringe provided to an employee of the taxpayer.” The IRS released Notice 2018-99 which requires employers to determine the “total parking expenses” which are disallowed under this code section.
– Notice 2018-99 provides 4 steps as a reasonable method to determine the disallowed portion of parking expense when parking facilities are owned or leased (either fully or partially). The disallowed portion of parking expense in this method always applies to reserved employee spots and applies to all parking spots if the primary use of the parking lot (greater than 50%) is employee use rather than use by the general public (i.e., clients, customers, etc.). The method then requires the employee use (%) of the lot to be disallowed and allows for deduction of the public use (%) of the lot.
-Notice 2018-99 implies that a portion of lease/rent payments should be allocated to parking expenses. In page 7 it says: “For purposes of this notice, ‘total parking expenses’ include, but are not limited to, repairs, maintenance, … and rent or lease payments or a portion of a rent or lease payment (if not broken out separately).”
So how does a financial executive allocate a portion of a company’s rent cost to the value of employee parking received? In other words, if you pay $2.50 per square foot, per month in your current building, it is not like you actually paid $2.40 in rent and there is some phantom value to the parking of $0.10. But this is now what the IRS is forcing business owners and financial executives to do. So what is something reasonably worth that no one charges for, and the market assigns no value for, yet whereby you have to derive a value?
A Case Study—a Software Company in a Concrete Tilt up Flex Building with an Office Use
What brought this to our attention was a recent question that one of our clients reached out for help with. The CFO’s auditor wanted to disallow 20% of the company’s rent payments as not being a deduction, as that is what the accountant arbitrarily assigned to the “parking value” portion of the lease payments.
To bring this to life, this was a 10,000-square-foot tenant occupying a “flex” concrete tilt up building in a suburban market called Carmel Mountain Ranch in San Diego, along the I-15 freeway. In that submarket, parking is universally free, as it is in all surrounding submarkets. The chief financial officer needed Hughes Marino to come to the defense of the company and help quantify the value of the parking. In this situation of disallowing 20% of the rent as an expense, their accountant would have disallowed $60,000 of the annual rent expense!
Now imagine that you are a large employer with 100,000 square feet, or a small business with 5,000 square feet, or a multi-state employer with millions of square feet. The IRS has found a way to sneak in billions of dollars of new taxes without financial executives and business owners even realizing it.
The “market” is that parking is free in all suburban buildings like this throughout San Diego County. That is the case for most suburban submarkets around the United States, outside of suburban mid-high rise and central business district submarkets. In cases where the landlord built parking garages, or underground or above ground structures, and the employee pays for parking or the employer pays on behalf of the employees, this accounting allocation under this new IRS code doesn’t apply, assuming that the tenant’s rent payment doesn’t make a contribution towards parking costs.
The Winning Logic Chain and How to Reasonably Quantify Parking Value
In order to defend the company’s interests, Hughes Marino’s line of argument was as follows. In these suburban submarkets where parking is generally surface parking only and most often free, the free parking is really an inducement for tenants to locate in the suburbs in lieu of being in a mid-high rise where parking is paid for separately. In other words, it is not intended to have value or cost implications. Landlords built these suburban buildings where the rent received pays for the building, land, the related improvements to the building and land, never intending that parking would be charged for or have any value. The market doesn’t break out “rent” for building shell rent, tenant improvements rent, bathroom rent, lobby rent, landscaping rent and parking rent. If it did, the portion of the rent dollar attributable to parking would be very small.
We considered the closest suburban office submarket where there is paid parking called UTC and parking ranges from $25 per month for surface parking and $60-$75 per month for structured parking. Given that our client had surface parking only, the highest value was potentially $25 per space, but that is in a Class A submarket 10 miles away. However, our client’s building is a “flex” R&D building and not even an office building, so arguably the parking value would be on the low end of any value scale. The fact is that not a single “flex” building in Southern California charges for parking. So, what is something worth when hundreds of millions of square feet of flex buildings don’t value or charge for parking? We determined that the maximum market value of the parking in this case was $10 per space, and the auditor agreed with our rationale and professional assessment. Given that the company had 40 employees in the space, the portion of the rent disallowed was $400 per month, or $4,800 per year, versus the initial $60,000 that the auditor was trying to disallow.
Please let us know if one of our team members can help your company with this same assessment of value exercise, as every financial executive in the United States is about to be faced with this, and we are prepared to help you protect your bottom line.