In June 2009 the IRS published Notice 2009-46, requesting comments on several proposed procedures for simplifying the substantiation and reporting requirements of employees’ personal use of employer-provided cellular telephones.
Under the current provisions of the Code and regulations, employees must substantiate, for each separate use of their employer-provided cell phones, the cost, date, and business purpose of the telephone’s use. An employee’s failure to comply with the substantiation requirements in a timely manner may result in the inclusion of the full fair market value (FMV) of the employer-provided cell phone in the employee’s gross income without an exclusion for business-related uses.
Congress added Sec. 280F to the Code with the enactment of the Deficit Reduction Act of 1984, P.L. 98-369. The intent of Sec. 280F was to identify certain personal property items that were acquired for business use but inherently lent themselves to personal use. The enumerated property, defined as listed property in Sec. 280F(d)(4), originally included passenger automobiles, computer equipment, and other property generally used for transportation, entertainment, and recreation. Congress added cellular telephones to the definition of listed property with the enactment of the Omnibus Budget Reconciliation Act of 1989, P.L. 101-239.
While the provisions of Sec. 280F identify and generally limit the use of accelerated depreciation for listed property, a companion provision, Sec. 274(d)(4), which also became law under the Deficit Reduction Act of 1984, prohibits any deduction or credit with respect to any listed property as defined by Sec. 280F(d) (4), unless certain substantiation and record-keeping requirements are met by the taxpayer. Congress’s intent with the codification of these measures was to tax the personal-use component of those specific property items identified in Sec. 280F(d)(4).
Twenty years ago, cell phones were relatively bulky and prohibitively expensive for most taxpayers. Use of cell phones was not widespread, and Congress did not envision their pervasive use in today’s business environment. Over the past two decades, technology and competition have reduced the size and cost of cell phones as well as their monthly service cost. Cell phones featuring internet and e-mail access, instant messaging, cameras, and GPS navigation have facilitated the extension of the workplace to almost anywhere and have effectively stretched the length of the workday to 24 hours. However, the substantiation and record-keeping provisions of Sec. 274(d)(4) have not kept pace with the cell phone’s role in today’s business environment, where the administrative burden of complying with the substantiation provisions of Sec. 274(d)(4) is disproportionate to the low operating cost and the pervasive use of the cell phone.
Many members of Congress have recognized the burdensome administrative cost of the existing substantiation and record-keeping provisions with respect to business cell phone use. In 2008 several bills were introduced in both the House and the Senate that would have either removed cell phones from the definition of listed property or ameliorated the burdensome substantiation requirements. None of the bills has become law.
In this context, Douglas Shulman, the IRS commissioner, expressed support for easing the substantiation requirements earlier this year and urged Congress to “make clear that there will be no tax consequence to employers or employees for personal use of work-related devices such as cell phones provided by employers” (www.irs.gov/ newsroom/article/0,,id=209795,00.html).
The stated purpose of Notice 2009-46 was to solicit comments from the public regarding three proposed simplified methods of substantiating employees’ business use of employer-provided cell phones, in addition to methods of determining the FMV of any taxable fringe benefit that accrues to employees for their personal use of employer-provided cell phones.
Simplified Substantiation Methods
The three proposed simplified substantiation methods listed in Notice 2009-46 are:
- A minimal personal-use method with two variants;
- A safe-harbor substantiation method; and
- A statistical sampling method.
Both variants of the minimal personaluse method would allow employers to deem all an employee’s use of an employerprovided cell phone as business use. Under the first variant, the employee would be required to provide the employer with sufficient records to establish that the employee maintains and uses a personal cell phone for personal use during business hours. The alternative minimal personaluse method proposed in Notice 2009-46 adopts a de minimis approach in which a certain amount of personal use would be disregarded and the entire amount of cell phone use would be deemed business use. The notice does not specify the amount that would be considered minimal personal use but suggests that the amount would be determined by a set number of allowable personal-use minutes.
Under the safe-harbor substantiation method, a flat percentage of each employee’s use of an employer-provided cell phone would be deemed as business use. The balance would be treated as personal use. In Notice 2009-46, the IRS and Treasury proposed a safe-harbor business use percentage of 75%.
Both variants of the minimal personal use method, as well as the safe-harbor substantiation method, would significantly reduce the substantiation and record-keeping burden of employers and employees alike. However, the de minimis approach would still require a certain amount of record keeping to determine whether the de minimis number of minutes had been exceeded.
The third simplified substantiation method enumerated in Notice 2009-46, the statistical sampling method, would allow employers to use statistical sampling techniques to determine an employee’s personal use of an employer-provided cell phone. Notice 2009-46 provides that methodologies similar to those outlined in Rev. Proc. 2004-29 (used to establish a taxpayer’s substantiated expenses paid or incurred for meals and entertainment that are not subject to the 50% deduction limitation) may be used to establish personal cell phone use. The remaining portion would be deemed business use.
Sampling methods have been available to taxpayers since 1986 but apparently have fallen short in addressing the simplification issue for employers providing cell phones to a large number of employees. Temp. Regs. Sec. 1.274-5T(c)(3)(ii) (A), effective for tax years beginning on or after January 1, 1986, provides that sampling may be employed to substantiate the business use of listed property. However, the sampling methodologies suggested in the examples cited in Temp. Regs. Sec. 1.274-5T(c)(3)(ii)(C) are more applicable to small businesses because they would require sampling for periods for each employee rather than sampling from the entire employee population. Rev. Proc. 2004-29 provides very specific guidance as to what sampling applications a taxpayer may use, including sampling techniques, population size, and others. Calculation of confidence limits is also required.
Determining FMV of Personal Use
To the extent any employer-provided cell phone use is not substantiated business usage, which would make it excludible from the employee’s gross income as a working condition fringe benefit, the FMV of the cell phone use is included in the employee’s gross income. Because the cost incurred by the employer is not determinative of the FMV of a fringe benefit under Regs. Sec. 1.61-21(b)(2), the IRS and Treasury have expressed interest in understanding the methods employers were using to determine the FMV to the employee of employer-provided cell phones.
With the increasing utility and decreasing costs of cell phones, they have become an integral component of business communications. When cell phones were first included in the listed property and subjected to stringent substantiation and record-keeping requirements, they were relatively costly and novel items. However, today their use has become pervasive, which means that the burden of substantiating the business use of cell phones and maintaining records as required under the current tax laws has increased relative to the cost of the cell phone use. The fact that members of Congress and the IRS have recognized the problem, and that the IRS has taken steps to remedy the issue by suggesting simplified methods and seeking public comment, will hopefully mean that more reasonable methods for determining business versus personal use as well as FMV are on the horizon.
Mark Cook is a partner at Singer Lewak LLP in Irvine, CA.
Unless otherwise noted, contributors are members of or associated with Singer Lewak LLP.The editor would like to offer a special thanks to Jennifer Allison, J.D., for her assistance with this column.
For additional information about these items, contact Mr. Cook at (949) 261-8600, ext. 2143, or email@example.com.