Commuter Benefits Overview: Part II

Question: What are the key legal restrictions for tax-advantaged commuter benefits?

Short Answer: Transit expenses must be incurred on the commuter debit card (not submitted for reimbursement), commuter contributions are not refundable (even at termination of employment), and there are new options to convert a parking balance to transit (or vice versa). On the plus side, employee commuter contributions are not subject to the Section 125 cafeteria plan irrevocable election limitations.

Note: This is the second in a two-part series addressing the commuter benefit rules: Part I: Commuter Benefits Overview

IRS Prohibition of Direct Employer Reimbursement for Tax-Free Transit Expenses
There has been a long-standing rule that cash reimbursement for transit passes is permitted under §132 as a non-taxable qualified transportation plan only if a voucher (or similar item which may be exchanged only for a transit pass) is not “readily available” in that area. This readily available test became extremely complex over time as the IRS issued numerous rulings attempting to define “readily available.”

Since 2016, the IRS determined that vouchers (including terminal-restricted debit cards) have become readily available throughout the country, and therefore they will not allow cash reimbursement anymore where terminal-restricted debit cards are readily available (essentially everywhere).

The result is that direct employer reimbursement of transit expenses on a tax-free basis through §132 is now prohibited. Therefore, employers can provide §132 tax-free mass transit benefits only through a terminal-restricted debit card (or old-fashioned commuter checks), which generally will require the employer to engage with a commuter benefits TPA. If the IRS were to discover the employer had utilized the cash reimbursement approach, it could recharacterize all reimbursements as taxable income to employees.

Example 1:

• Robert Paulson is an automobile recall specialist working in downtown Los Angeles.

• He uses his commuter debit card to fund for his transit pass to ride the light rail to the office daily.

• One day he forgets to take his transit pass and therefore has to pay for the rail by credit card.

Result 1:

• Robert cannot be reimbursed for the cost of his transit pass because he must use the commuter debit card to pay for any transit pass at the point of purchase.

• Even with an itemized receipt clearly showing the transit pass purchase, there is no option to later submit a transit claim for reimbursement.

New Option to Roll Over Parking to Transit (Or Vice Versa)
The IRS issued guidance in 2020 providing that employers can structure the commuter benefit program plan design to permit rolling over unused parking benefit amounts to be allocated to the transit benefit balance, as long as the maximum monthly amount ($325 in 2025) is not exceeded.

On the flip side, the guidance also permits commuter benefit plans to allow employees to roll over unused transit benefit amounts to be allocated to the parking benefit balance, as long as the maximum monthly amount ($325 in 2025) is not exceeded.

This commuter benefit program ability to roll over unused parking balance to transit and vice versa is an optional plan design feature. Employers wishing to offer this relatively new rollover feature will want to consult with their commuter account TPA to confirm the offering.

• For more details: Commuter Accounts When Expenses Dry Up

Example 2:

• Judy Bernly works 9 to 5 at Consolidated Companies in downtown San Francisco.

• She had been driving to work and using the qualified parking benefit, with a balance of $200 remaining.

• However, with more people returning to office, she has decided to take BART (subway) to avoid traffic.

Result 2:

• Assuming the Consolidate Companies’ commuter plan permits it, Judy can roll over her $200 qualifying parking benefit balance to the mass transit benefit.

Employee Pre-Tax Contributions Permitted (But Not Through Section 125 Cafeteria Plan)
Employee pre-tax contributions up to the tax-advantaged monthly limit ($325 in 2025) are permitted through a §132(f) safe harbor from constructive receipt. Commuter benefits have the proud distinction of being the only health and welfare benefit for which employees may contribute pre-tax outside of a Section 125 cafeteria plan. There are a few important differences between the §132 and §125 rules for this purpose.

Employees May Change Their §132 Commuter Benefit Elections Monthly
One big difference between commuter benefits and FSAs is that the period of coverage for commuter benefits can be (and almost always is) limited to only one month. The only limitation on an employee changing a commuter benefit election is that it must be prospectively before the next month’s period of coverage, and it must be irrevocable for that one-month period.

In other words, the Section 125 cafeteria plan irrevocable election rule does not apply to commuter pre-tax elections. Under the separate Section 132 exemption from constructive receipt (that applies to employee pre-tax mass transit/vanpooling and parking contributions), employees can change their contribution election prospectively each month before the month begins. This permits employees to freely join, increase, decrease, or revoke commuter benefit elections each month for any reason. Those elections are generally effective for the following month, and in most plans they will continue indefinitely until modified by the employee.

Employees should take advantage of this flexibility to ensure they do not build up a large balance of unused commuter contributions that will forfeit upon termination. For example, employees whose commuter expenses decrease or dry up entirely should elect to reduce or discontinue contributions.

• For more details: Monthly Commuter Benefit Election Changes

No Use-It-Or-Lose-It Rule Tied to End of a Plan Year
As described above, commuter benefits are non-refundable and must forfeit upon termination. However, the Section 125 cafeteria plan use-it-or-lose-it rule that applies to unreimbursed FSA balances at the end of the plan year does not apply to commuter benefits.

In fact, the plan year concept does not even apply under §132(f) to commuter benefits. Commuter benefits are simply a month-to-month benefit with balances that continue to roll month-after-month, and year-after-year, as long as the employee remains eligible for the benefit. The result is that (unlike FSAs) employees do not have to spend down their commuter benefit balance by the end of the year to avoid potential forfeitures.

• For more details: The Section 125 Cafeteria Plan Use-It-Or-Lose-It and Forfeiture Rules

Cafeteria Plan Flex Credits Cannot be Allocated to Commuter Benefits
Because the basis for employee pre-tax contributions is outside §125, employers cannot permit employees to allocate cafeteria plan flex credits to tax-advantaged commuter benefit options.

• For more details: The Section 125 Cafeteria Plan Safe Harbor from Constructive Receipt

Section 132(f) Bicycle Commuter Benefits: Discontinued by TCJA
The Tax Cuts and Jobs Act of 2017 eliminated the $20 tax-free benefit (originally added in 2009) that permitted employers to reimburse certain bicycle commuting benefits. The repeal was effective in 2018, but it is currently scheduled to sunset at the end of 2025. Accordingly, absent a further act of Congress to extend or make permanent the elimination, this “little tax break that could” might make its triumphant return in 2026.

Note that the bicycle reimbursement benefit did not permit employee pre-tax contributions, and it was not indexed for inflation.

For more details:

• Final Tax Cuts and Jobs Act Passes Congress

• The Bicycle Commuting Expense Reimbursement Benefit

Commuter Benefit Contributions Not Refundable
A key limitation of the §132(f) rules that govern tax-advantaged commuter benefit programs is that employers cannot refund, cash-out, or in any manner reimburse employees for the unused amount of their commuter benefit contributions.

In other words, the §132 rules are clear that the employee cannot subsequently receive the compensation that was contributed to the commuter account in cash or any form other than by payment of a qualifying commuter expense under the employer’s plan. This means the employee cannot be cashed out (even on a taxable basis) for any unused commuter balance—regardless of whether the employee is no longer incurring qualifying commuter expenses.

Furthermore, only current employees can participate in the commuter account. The §132(f) rules prohibit participation in commuter benefits for terminated employees. The prohibition on refunds or cash outs of unused commuter account balances also extends to situations where the employee ceases to participate, such as termination of employment—whether voluntary or involuntary.

The stark result for terminated employees is they cannot a) receive a refund (even on a taxable basis) of any remaining commuter account balance, or b) use the remaining commuter funds for continued commuter expenses post-termination. Section 132(f) simply requires the forfeiture of the remaining balance after any applicable run-out period. Employers cannot make exceptions to these strict legal limitations because failure to follow the rules runs the risk that all employees would lose the pre-tax benefit of their commuter elections if discovered by the IRS.

Any unused commuter balance upon termination must be forfeited to the employer after any applicable run-out period. Employers may retain the forfeitures, allocate them evenly to the accounts of other commuter participants, use the amounts for plan administrative expenses, or use them for any other purpose. Unlike the cafeteria plan rules applicable to experience gains caused by FSA forfeitures, there are no rules governing employer use of commuter account forfeitures.

For more details:

• Commuter Accounts When Expenses Dry Up

• Commuter Benefits Upon Termination of Employment

Example 3:

• Peter Gibbons contributes pre-tax to his commuter benefit plan through Initech Corporation to use the mass transit benefit take the bus to work.

• When he is involuntarily terminated (i.e., fired) from his job at Initech, Peter still has $200 left in his commuter plan.

Result 3:

• Peter forfeits the full $200 commuter plan balance as of the date of his termination from employment.

• There is no option for Initech to reimburse Peter for the lost balance—even on a taxable basis.

• Employees such as Peter should prudently manage their commuter plan balance to avoid forfeitures upon termination—which might be sudden and expected, with no way to spend down the balance.

Sample Language to Terminated Employees—Required Forfeiture of Commuter Benefit Contributions
The Internal Revenue Code governs commuter benefit plans. Pursuant to IRS regulations, employees who cease to participate in the plan (for example, because of termination of employment) must forfeit any contribution amounts remaining in their commuter benefit account. Commuter contributions are not refundable (even on a taxable basis) under any circumstances, including upon termination of employment. (Treas. Reg. §1.132-9, Q/A-14(d)).

The Company cannot make any exception to these forfeiture requirements because failure to follow the terms of the Internal Revenue Code and applicable IRS regulations could cause the entire commuter benefit plan to lose its tax-advantaged status. If this were to occur, all of the company’s employees participating in the commuter benefit plan would be taxed on their commuter benefit elections.

For more details on commuter benefits, see our Newfront Fringe Benefits for Employers Guide.

Relevant Cites:

IRC §132(f):
(4) No constructive receipt.
No amount shall be included in the gross income of an employee solely because the employee may choose between any qualified transportation fringe (other than a qualified bicycle commuting reimbursement) and compensation which would otherwise be includible in gross income of such employee.

Treas. Reg. §1.132-9, Q/A-14:
(d) Compensation reduction amounts not refundable. Unless an election is revoked in a manner consistent with paragraph (c) of this Q/A-14, an employee may not subsequently receive the compensation (in cash or any form other than by payment of a qualified transportation fringe under the employer's plan). Thus, an employer's qualified transportation fringe benefit plan may not provide that an employee who ceases to participate in the employer's qualified transportation fringe benefit plan (such as in the case of termination of employment) is entitled to receive a refund of the amount by which the employee's compensation reductions exceed the actual qualified transportation fringes provided to the employee by the employer.

IRS Information Letter 2020-0031:
In no case, however, may the employer provide a cash refund, even when the employee’s compensation reduction amounts exceed the employee’s qualified transportation fringes. Regulations Section 1.132-9, Q&A 14. In other words, an employee may receive a cash reimbursement of compensation reduction amounts only as a reimbursement of qualified transportation fringes.

Information Letter 2020-0024:
However, an employee is not precluded from later receiving the compensation through the use of another qualified transportation fringe, such as qualified parking, to the extent it is offered by the employer’s plan and it does not exceed the maximum monthly amount for the respective qualified transportation fringe benefit.

…

In addition, an employee is permitted to use the unused amounts for other qualified transportation fringe benefits offered under the employer’s plan, such as qualified parking, as long as the fringe benefits satisfy all other requirements outlined in Section 1.132-9 of the regulations and the unused amounts do not exceed the maximum monthly limitation for the respective qualified transportation fringe benefit.

IRS Information Letter 2019-002:
When an employee is fired, compensation reduction amounts are not refundable to the employee. This applies even though the employee’s contributions may exceed the actual qualified transportation benefits the employer provided to the employee. As stated in Treasury Regulation Section 1.132-9, Q/A-14, this rule does not distinguish between employees who are fired (or involuntarily terminated) and those that quit their employment voluntarily.

Employees who stop participating in an employer’s qualified transportation benefit plan without cancelling their compensation reduction election cannot receive a refund of any amount. In addition, the terminated employee cannot use the funds for continued transportation expenses.

IRS Revenue Ruling 2014-32:
Accordingly, the provision included in Rev. Rul. 2006-57 permitting employers to use cash reimbursement if the only available voucher or similar item is a terminal-restricted debit card is no longer warranted. Beginning after December 31, 2015, in order to provide time for employers to comply, employers are no longer permitted to provide qualified transportation fringe benefits in the form of cash reimbursement in geographic areas where a terminal-restricted debit card is readily available.

…

Situation 8. Beginning after December 31, 2015, the value of the transit benefits provided by H to its employees through a cash reimbursement arrangement is not excluded from gross income under § 132(a)(5) and is wages for employment tax purposes.

Disclaimer: The intent of this analysis is to provide the recipient with general information regarding the status of, and/or potential concerns related to, the recipient’s current employee benefits issues. This analysis does not necessarily fully address the recipient’s specific issue, and it should not be construed as, nor is it intended to provide, legal advice. Furthermore, this message does not establish an attorney-client relationship. Questions regarding specific issues should be addressed to the person(s) who provide legal advice to the recipient regarding employee benefits issues (e.g., the recipient’s general counsel or an attorney hired by the recipient who specializes in employee benefits law).