IRS has resolved a longstanding issue concerning whether the provision of cell phones to employees (either directly or through cost reimbursement) results in any tax to the employee. Under rules announced by IRS, as long as the phone service is provided primarily for good business reasons, neither business nor personal use of the phone will be taxed, nor will employers or employees have to substantiate the amount of business use, or determine the amount of personal use. IRS provided examples of good business reasons that should be easy for most businesses to meet.
The Full Story:
Today’s tax quote:
“As a taxpayer, you are required to be fully in compliance with the United States Tax Code, which is currently the size and weight of the Budweiser Clydesdales.” -- Dave Barry
Vividly illustrating the frustrating size and weight of the Code, the long-running saga of how (or whether) to tax the value of cell phones provided to employees has been resolved by a new IRS Notice, and by instructions to its field examiners, that should result in few if any instances of taxation notwithstanding a maze of Code sections that are weighty, to say the least.
The issue first arose in a 2008 Tax Court case, in which the IRS successfully asserted that a self-employed businessman could not deduct the costs of business use of his cell phone because he was unable to meet the very strict statutory substantiation rules that applied to such property. Under the law that applied at the time, cell phones were specifically included as “listed property” in Section 280F(d)(4) of the Code (along with such property as automobiles) which are subject to detailed substantiation as to business versus personal use. Under Section 274(d)(4) of the Code, for listed property the taxpayer must substantiate by adequate records the amount of each expense, the use of the property, the business purpose of each use of the property, and the business relationship to the taxpayer of each person using the property. These rules are designed to eliminate deductions for personal use of dual-use property like personal cars used in business, but obviously are difficult to apply to property such as a cell phone for which the accounting required to distinguish personal from business use, and satisfy the substantiation requirements, is daunting to say the least.
The issue caused headaches both for businesses that either provide a cell phone to employees or reimburse the employees for their own cell phones, and for the IRS. The latter, which was stuck with the statutory substantiation requirement discussed above, set about trying to devise shortcuts that would allow businesses to estimate business versus personal use. Businesses, for their part, began a campaign to get Congress to change the law, an effort supported by the IRS.
Congress eventually acted, and in the Small Business Jobs Act of 2010 removed cell phones from the category of listed property. However, this did not fully resolve the problem.
If property or a service is provided to an employee by the employer for business reasons, the business use or the property or service will qualify as a nontaxable “working condition” fringe benefit. That is because the employee’s business use of the property or service on behalf of the employer would be deductible as an employee business expense by the employee if the employee used or paid for his or her own property or service, and therefore the business use of the property or service is excludable if the employer provides it. This rule would apply to employer-provided cell phones. However, business use of such property must still be substantiated (albeit with less stringent rules than apply to listed property). And any personal use would still be taxable to the employee.
Moreover, under Section 1.132-5(a)(1)(v) of the regulations, cash does not qualify as a working condition fringe benefit unless the employer requires the employee to use the cash for a specific or prearranged activity for which a deduction would be allowed, verify that the payment is actually used for that purpose, and return any part of the payment not used for the prescribed purpose. Many employers, particularly small businesses, do not provide employees with cell phones, but provide reimbursements or a cash allowance to defray the employee’s use of his or her own cell phone. Such plans generally would not qualify for exclusion of the benefit if the regulation was strictly applied.
Recognizing the problems these rules would cause if strictly interpreted, IRS has provided flexible rules for cell phones that should result in few instances of taxability.
In Notice 2011-72 (September 14, 2011), IRS says that if an employer provides a cell phone to an employee “primarily for noncompensatory business reasons,” IRS will treat the value of phone as meeting the conditions for exclusion of a working condition fringe benefit. For the Notice, see http://www.irs.gov/irb/2011-38_IRB/ar07.html. It goes on to say that, solely for the purpose of determining whether the working condition fringe benefit exclusion applies, it will also treat the substantiation requirements as having been met. An employer will be considered to have provided the phone for a noncompensatory business purpose if there are “substantial reasons relating to the employer’s business,” including as examples the need to contact the employee at all times for work-related emergencies, the employer’s requirement that the employee be available to speak with clients at times when the employee is away from the office, or the employee’s need to speak with clients located in other time zones or at times outside the employee’s normal work day.
Further, employers and employees will not have to determine whether there is also personal use, and if so how much. IRS says any value of personal use will be considered a “de minimis” fringe benefit under Section 132(a)(4) of the Code, and not taxable. This is an expansive use of the de minimis fringe benefit provision, which applies to property or services the value of which (after taking into account the frequency with which similar benefits are provided to other employees) is so small as to make accounting for it unreasonable or administratively impractical. IRS has in the past interpreted this provision very restrictively, and in Notice 2011-72 makes clear that its looser application to cell phone use should not be taken as applying to any other fringe benefits.
Finally, at the same time IRS also released a memorandum providing guidance to Revenue Agents on the application of these rules to instances in which the employer provides cash rather than a phone. For the memorandum, see http://www.irs.gov/pub/foia/ig/sbse/sbse-04-0911-083.pdf. According to the memorandum, if the employee is required to use his or her own cell phone and maintains the type of cell phone coverage that is reasonable related to the needs of the employer’s business, the reimbursement is reasonable calculated so that it does not exceed the expenses actually incurred, and the reimbursement is not a substitute for a portion of the employee’s wages (that is, wages are not reduced by the amount of the cell phone allowance), then examiners should not seek to tax the reimbursements.
Under these rules, most employer plans to provide for cell phone use by employees should not result in any tax liability for the employee. This is a welcome development that puts to rest a rather difficult issue that has plagued businesses and the IRS for several years. Even the Budweiser Clydesdales are no doubt pleased.
Posted by Peter K. Scott