Many businesses are now allowing employees great flexibility to choose their work location. A common work arrangement allows an employee to regularly work remotely (e.g., from their personal residence) and to work in the employer’s office as needed. Employers are asking whether the expenses incurred by the remote employee to travel to the office can be reimbursed on a tax-free basis. The answer hinges on whether the travel from the employee’s workplace in their personal residence to the employer-provided office is considered a personal commute or a business trip.
Employers should exercise caution when determining the tax consequences of costs incurred for employee travel between their personal residence and the employer’s office or another work location. Only payments for certain types of transportation and travel expenses are tax free to the employee. Employers that erroneously exclude expenses from their employees’ W-2 taxable income could become liable for both the employer’s and employee’s shares of all income and employment taxes due on the compensation, as well as be denied deductions for the expenses paid. Given the increase in the number of employees working remotely since the start of the pandemic, employers should carefully examine their employee travel and transportation policies and practices, including those for prior years, to determine whether they are in compliance with current tax rules.
To be tax-free to the employee, amounts paid by an employer for travel from the employee’s personal residence to the employer’s office or another work location must meet the requirements of either a qualified transportation fringe (QTF) benefit or a working condition fringe benefit.
Qualified Transportation Fringe Benefits
Commuting expenses provided to an employee are a tax-free benefit only if they satisfy Internal Revenue Code (IRC) Section 132(f). Under Section 132(f), employers can provide tax-free QTR benefits of up to a monthly limit ($280 for 2022) for each of the following:
- Transportation in a commuter highway vehicle between the employee’s residence and place of employment,
- Any transit pass, or
- Qualified parking.
While commuting benefits are often provided as monthly parking contracts or transit passes, the QTF exclusion can be applied to ad hoc reimbursements with the required documentation.
Working Condition Fringe Benefits
Many modes of transportation (i.e., personal auto, taxi, Uber, Lyft, airplane, etc.) are not considered a QTF but can still be provided tax-free to an employee as long as the benefit qualifies as a Section 132(d) working condition fringe benefit. A working condition fringe benefit is any property or service provided to an employee that the employee could deduct¹ if they paid for the property or service. Whether a travel or transportation expense would be deductible by the employee requires a facts and circumstances analysis under a body of IRS and judicial guidance dating back to the 1940s focusing on the employee’s “tax home,” which does not address today’s widely accepted remote work arrangements.
Employees who have one or more regular work locations away from their residence (such as the employer’s office) may deduct daily transportation expenses incurred in traveling between their residence and a temporary work location, regardless of the distance. When the employee’s primary work location is the employer-provided office, a drive to a customer (a temporary work location) directly from their personal residence is business mileage incurred for the benefit of the employer that can be reimbursed by the employer as a tax-free working condition fringe.
However, when an employee works primarily from their personal residence, different rules apply. The transportation expenses incurred in going between the residence and another work location (regular or temporary) in the same trade or business and within the same geographic area can be reimbursed tax free only if the residence is the employee’s “principal place of business” as defined by Section 280A(c)(1)(A). Among other requirements, this definition includes an “exclusive use” rule, which provides that the portion of the personal residence used by the employee for business purposes must be used exclusively on a regular basis for business purposes and must be used for the convenience of the employer (not for the convenience of the employee) based on the facts and circumstances.
Although the exclusive use rule was put in place to prevent abuse when deducting household expenses as unreimbursed employee business expenses on Form 1040, Schedule A (Itemized Deductions), the IRS also applies the rule (via Rev. Proc. 99-7) when determining the tax treatment of an employee’s business expenses of local daily travel to and from their personal residence. Satisfaction of the existing Section 280A(c)(1)(A) language is impossible for taxpayers who do not have the ability to set aside a portion of their personal residence exclusively as a workspace. In addition, it is problematic for employers to gather information regarding the exclusive use test prior to reimbursements of local daily travel expenses.
The exclusive use rule does not apply to travel from a personal residence located outside the metropolitan area of the employer-provided office, but complications arise where employees live far away from their employer. Three conditions must be satisfied before the travel is deductible and, therefore, reimbursable as a tax-free working condition fringe benefit under Section 132(d):
- The expense must be reasonable and necessary, as these terms are generally understood;
- The expense must be incurred while away from home; and
- The expense must be incurred in pursuit of the employer’s business.
If all three of the above criteria are not satisfied, an employer’s reimbursement of an employee for the cost of the trip from a personal residence outside the geographic area in which the employer provides a workspace will be classified as personal commuting.
In its 1946 decision Commissioner v. Flowers² , the U.S. Supreme Court disallowed a deduction for travel expenses based on the criteria that the expense must be incurred in pursuit of the employer’s business, ruling that the employer gained nothing from the employee’s decision to reside in a different city. The Supreme Court found that the expenses were irrelevant to carrying on the employer’s business. Also see, Wilbert v. Commissioner (2009)³ and Tucker v. Commissioner (1976)4.
For example, assume an employer allows an employee to work Monday and Friday from their home in Florida but requires them to be in the New York office Tuesday, Wednesday and Thursday. The employer does not require the employee to be in Florida. If the employer pays for the Florida to New York trips, the expense should be reported as taxable wages to the employee.
Lost Deductions for Employer
Generally, employers can deduct taxable wages paid to employees. However, the Tax Cuts and Jobs Act added IRC Section 274(l) Transportation and Commuting Benefits, which specifically disallows employer deductions for any expense incurred to provide transportation, or any payment or reimbursement for transportation, to an employee in connection with travel between the employee’s residence and place of employment, except as necessary to ensure the safety of the employee. Working condition fringe benefits avoid this disallowance, therefore a retroactive reclassification from treatment as a working condition fringe benefit to a commuting expense (whether taxable or nontaxable to the employee) could impact the employer’s income tax liability.
To date, the IRS has not issued guidance that addresses modern-day reasons for allowing tax-free reimbursements to remote workers for expenses of travel to the employer-provided workplace. Although the U.S. Supreme Court’s reasoning in the Flowers case was that the employer gained nothing from the employee’s decision to work remotely, there now may be arguments that having remote employees offers benefits to the employer’s business such as reduced occupancy costs, reduced relocation expenses, an expanded candidate pool for hard to fill positions, reduced training costs via reduced turnover, reduced payroll costs where employees are located in areas with lower costs of living, enhanced green initiatives, etc. It remains to be seen whether the IRS will eventually be open to reasonable arguments that employers are benefitting when their workforce chooses to work remotely, which could allow more employee transportation and travel to be considered business trips.
Written by Joan Vines. Copyright © 2022 BDO USA, LLP. All rights reserved. www.bdo.com
1 Due to the TCJA’s suspension of the deduction for unreimbursed employee expenses for 2018 through 2025, employees cannot currently deduct employee business expenses on their personal income tax returns, but the deductibility criteria still apply for determining what qualifies as working condition fringe benefits.
2 Commissioner v. Flowers, 326 U.S. 465 (1946).
3 Wilbert v. Commissioner, 553 F.3d 544 (7th Cir. 2009).
4 Andrews v. Commissioner, 931 F.2d 132 (1st Cir. 1991).