IRS Issues Guidance, Requests Comments on Smart Cards and Debit Cards Used for Transit Fares

The IRS asked for comments on May 25 on issues regarding the use of smart cards and debit or credit cards to pay transit fares (Notice 2012-38). It also announced that its previous guidance on the use of electronic media to provide employees with qualified transportation fringe benefits (Rev. Rul. 2006-57) took effect Jan. 1, 2012 . The effective date had been delayed several times to give transit systems more time to modify their technology to be compatible with the rules, but taxpayers could rely on the ruling even before it took effect.

The notice and revenue ruling give employers guidance on how to provide smart cards and debit or credit cards to employees to pay for qualified transportation fringe benefits that will be excludible from income under Sec. 132.

Rev. Rul. 2006-57 contains illustrations of four situations in which smart cards or debit cards are provided to employees and describes whether they qualify as transit system vouchers. Under the Sec. 132, employers may provide cash reimbursement of transit expenses only if vouchers or similar items are not “readily available.” In the revenue ruling:

1. Smart cards provided to employees that cannot be used to purchase anything other than transit fares and that the employees are not required to substantiate their use of are qualified transportation fringe benefits.
2. Debit cards provided to employees that can be used at points of sale where only transit fares may be purchased and that the employees are not required to substantiate their use of are also qualified transportation fringe benefits. These are referred to as “terminal-restricted debit cards.”
3. Debit cards provided to employees that can be used at merchants that sell transit fares, but also may sell other merchandise, and where transit passes are not considered readily available, are not qualified transit system vouchers. In these circumstances, the employer is permitted to distribute benefits using a cash reimbursement plan, as long as the employees must pay with after-tax amounts in their first month of participation and are required to substantiate their monthly expenses.
4. The fourth situation involves providing debit cards in advance to employees, which does not qualify because the rules only permit reimbursement of expenses after they have been incurred.

The IRS explained in the notice that when Rev. Rul. 2006-57 was issued there was not sufficient information to determine whether terminal-restricted debit cards were “readily available.” Until the IRS issues guidance, employers are permitted to use cash reimbursement arrangements when the only available voucher or similar item is a terminal-restricted debit card.

As more and more transit systems use electronic payment methods, the IRS has become aware that it needs to update the rules. To that end, the IRS has requested comments on (1) circumstances in which the use of merchant-restricted debit cards are sufficiently circumscribed so that they qualify as transit passes, (2) the definition of “readily available” in light of the wider availability of terminal-restricted debit cards, (3) challenges employers face in the transition from paper transit system vouchers to electronic vouchers or to bona fide cash reimbursement systems, and (4) how to apply the reimbursement rules to benefits provided by electronic media.

Comments should be sent to the IRS by Aug. 27, 2012, at the address listed in the notice.