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CCH® BENEFITS — 12/04/06

IRS Transit Guidelines Detail How To Implement SmartCards And Debit Cards

from Spencer’s Benefits Reports: The Internal Revenue Service has ruled on substantiation requirements in four hypothetical situations regarding the use of smartcards and debit cards to provide qualified transportation fringes under section 132(f) of the Code. Three of the described substantiation methods are qualified transit system vouchers or a bona fide reimbursement arrangement for transit passes, and thus the value of the transit benefits is excluded from employees’ gross incomes. The fourth method is neither a qualified transit system voucher nor a bona fide reimbursement arrangement for transit passes, and thus the value of the transit benefits in this case is included in employees’ gross incomes.

Guidance about this is presented in Rev. Rul. 2006-57, I.R.B. 2006-47, dated Nov. 20, 2006.

Qualified Transit System Vouchers

In two of the situations described in the revenue ruling, the employers provide either smartcards or a debit cards that restrict employee use to the transportation benefits allowed under the employer plan and which are restricted to the transit limits set by the IRS each year.

The smartcards are plastic cards containing a memory chip that stores certain information, including the serial number of the card and the value of the fare card stored on the card. The amount stored on the smartcard is not authorized to be used to purchase anything other than transit fares for the employer.

The debit cards are restricted for use only at merchant terminals at points of sale at which only fares for the specified transit system is sold. The employers do not require employees to substantiate their use of the smartcards or the debit cards.

According to Rev. Rul. 2006-57, the smartcard and the debit card qualify as transit system vouchers, and the value of the transit pass benefits provided through them is excluded from gross income under IRC Sec. 132(a)(5) and from wages for employment tax purposes.

Bona Fide Reimbursement Arrangement

In the final two situations described in Rev. Rul. 2006-57, the employers provide debit cards that are restricted to merchants that have been assigned a merchant category code (MCC) indicating that the merchant sells transit fare cards. The merchant may or may not sell other merchandise.

In the third case, the employee pays for fare cards with after-tax amounts for the first month an employee participates in the program. The employee then substantiates the amount of fare expenses incurred during the month, and reimbursement amounts are allocated to the debit card. In subsequent months, the employee’s debit card is filled with an amount equal to the amount of fare expenses substantiated under the following procedures:

• With respect to expenses that were paid using the MCC-restricted debit card, periodic statements provide information on the use of each debit card, which include information on the identity of the merchants at which the debit card was used, and the date and amount of the debit card transactions.
• For the first month the debit card is used and, prior to providing reimbursement, the employee must certify that the debit card was used only to purchase fare cards.
• For subsequent months, employee certification is not required prior to reimbursement of recurring expenses that match expenses previously substantiated (for example, for an employee who purchases a transit pass on a regular basis from the same seller).

A recertification is required at least annually from each employee. The periodic statements are reviewed with the employee certifications to determine reimbursements.

With respect to fare card expenses that were not paid using the MCC-restricted debit card, the employees substantiate the amount of the fare card expenses incurred following reasonable substantiation procedures in IRC Reg Sec. 1.132–9(b) Q/A–16(c).

The IRS makes the following conclusions in regard to the third case:

• The debit card provided does not qualify as a transit system voucher because it is possible that a MCC-restricted debit card may be used to purchase items other than transit passes.
• With respect to expenses incurred during the first month an employee participates, and with respect to expenses not paid using the MCC-restricted debit card, the employer has implemented reasonable substantiation procedures.
• With respect to expenses paid using the MCC-restricted debit card, the employer has established a bona fide reimbursement arrangement for transit passes.
• The value of the transit pass benefits through the use of the MCC-restricted debit card is excluded from gross income under IRC Sec. 132(a)(5) and from wages for employment tax purposes.

Although the IRS is reviewing cases in which cash reimbursement is permissible even when terminal-restricted debit cards are used, the revenue ruling notes that until further guidance is issued, the Service will not challenge the ability of employers to provide qualified transportation fringes in the form of cash reimbursement when the only available voucher is a terminal-restricted debit card.

Sec. 132 Rules Not Followed

In the fourth and final case described in the revenue ruling, the facts are the same as in the third case above, except for the following situations:

• The employer provides employees with MCC-restricted debit cards as soon as they begin work. Prior to using the MCC-restricted debit cards.
• The employees certify that the card will be used only to purchase transit passes. In addition, written on each debit card is the statement that the card is to be used only for transit passes, and, by using the card, the employee certifies that the card is being used only to purchase transit passes.
• At no time do employees substantiate the amount of fare card expenses that have been incurred.

In this situation, the MCC-restricted debit card does not qualify as a transit system voucher. Because the employer is providing restricted-use debit cards that are not transit system vouchers, and because the employer is not using a bona fide reimbursement arrangement, the amounts provided through the use of the MCC-restricted debit cards are included in its employees’ gross income and wages.

This revenue ruling is effective Jan. 1, 2008, although employers and employees may rely on this revenue ruling with respect to transactions occurring prior to that date 2008.

For further information, contact John Richards of the Office of Associate Chief Counsel (Tax Exempt & Government Entities) at (202) 622–6040.

For more information on this and related topics, consult the CCH Pension Plan Guide, CCH Employee Benefits Management, and Spencer's Benefits Reports.

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