Expenses & Deductions
In today’s environment, immediate access to information, e-mail, and clients has become essential to carrying on a business. Employers have responded by either providing their employees with cell phones (in which case the employer directly pays the cost of the cell phone plan) or reimbursing their employees for the cost of the cell phone plan (collectively referred to as an employer-provided cell phone). The employee’s use of the cell phone results in taxable income to the employee unless certain requirements are met.
On September 27, 2010, President Barack Obama signed into law the Small Business Jobs Act of 2010, P.L. 110-240, which includes a provision that changes how tax law applies to an employee’s use of an employer-provided cell phone. However, it is unclear whether this change provides the much-needed relief that many tax practitioners, employers, and the public desired.
Prior to the act, cell phones were included under the Sec. 280F definition of “listed property.” Listed property refers to property specifically listed under Sec. 280F(d)(4), which is considered to inherently lend itself to personal use. Other listed property includes passenger automobiles and any other property used as a means of transportation; property generally used for entertainment, recreation, or amusement; and computers.
Under prior law, in order to receive a deduction related to listed property for cell phones, the strict substantiation requirements of Sec. 274(d) had to be met. To meet these requirements, employees were required to give the employer monthly statements that set forth the amount of the expense (including the purchase price of the cell phone, monthly service charges, and any additional per minute, roaming, long-distance, or other operating charges), the time and date of each call, and the business purpose of each call. Employees were required to distinguish those calls that were personal in nature from those calls that were business related. Over the years, the IRS routinely raised the issue of cell phones in its audits, and the courts sustained the requirements of detailed substantiation for cell phones under Sec. 274(d).
Compliance with Sec. 274(d) was required not only for employers to obtain a deduction related to cell phones but also for employees to escape taxation on the business use of cell phones. The business use of a cell phone may be excluded from an employee’s income as a working condition fringe benefit under Sec. 132(d). A working condition fringe benefit is any property or service provided to an employee to the extent that, if the employee paid for the property or service, the amount the employee paid would be deductible under Sec. 162 or 167. Regs. Sec. 1.132-5(a)(1)(ii) provides that if, under Sec. 274, certain substantiation requirements must be met in order for a deduction under Sec. 162 or 167 to be allowable, those requirements apply in determining whether a property or service is excludible as a working condition fringe benefit. Thus, if the employer did not collect the required substantiation of the employee’s use of the cell phone, the entire value of the cell phone was includible in the employee’s income.
Because it believed that the cell phone substantiation requirements were outdated, Congress removed cell phones from the definition of listed property under Sec. 280F for tax years beginning after December 31, 2009. This means that starting in 2010, an employee’s use of an employer-provided cell phone is no longer subject to the strict substantiation requirements of Sec. 274(d). However, this does not mean that employers and employees can ignore the personal use of employer-provided cell phones. Employer-provided cell phones are still a fringe benefit and must still meet certain requirements in order to be excludible from income. These requirements are found in Sec. 132.
There are two alternatives for excluding cell phones from income under Sec. 132. Specifically, employer-provided cell phones may be excluded either as a working condition fringe (as discussed above) or as a de minimis fringe. A working condition fringe is any property or service provided to an employee to the extent that, if the employee paid for the property or service, the amount the employee paid would be deductible under Sec. 162 or 167. Thus, in order to deduct the cost of the cell phone, the phone must be used for business purposes, and the employee must be able to substantiate this to the employer. This may be difficult to accomplish without requiring the employee to keep detailed records of the business and personal uses of the phone.
The other alternative for excluding cell phones from income is use of the de minimis fringe benefit rules. A de minimis fringe is not included in the employee’s gross income even if it is personal in nature. The term refers to any property or service the value of which is (after taking into account the frequency with which the employer provides similar fringes to the employee) so small as to make accounting for it unreasonable or administratively impracticable. Thus, it is possible for an employer to argue that the value of the personal use of a cell phone is so small that accounting for it is administratively impracticable or unreasonable. However, the frequency with which the employee uses the employer-provided cell phone for personal reasons may be detrimental to the argument that any personal use is excludible from an employee’s gross income as a de minimis fringe.
It is unclear at this time whether Treasury and the IRS will issue guidance on the tax treatment of employer-provided cell phones under the Small Business Jobs Act. The Joint Committee on Taxation provided in a footnote in its technical explanation of the act that the new law “does not affect Treasury’s authority to determine the appropriate characterization of cell phones as a working condition fringe benefit under section 132(d) or that the personal use of such devices that are provided primarily for business purposes may constitute a de minimis fringe benefit, the value of which is so small as to make accounting for it administratively impracticable, under section 132(e)” (Joint Committee on Taxation, Technical Explanation of the Tax Provisions in Senate Amendment 4594 to H.R. 5297, the “Small Business Jobs Act of 2010” (JCX-47-10) at 25, n. 90 (September 16, 2010)). Perhaps the IRS will issue guidance on the degree of substantiation between business and personal use that is required for purposes of the working condition fringe benefit exclusion. It is also possible that the IRS will issue guidance as to when the de minimis fringe rules can be used so that substantiation of the business and personal use of cell phones will not be required.
Employers should carefully consider how to continue with their cell phone policies in light of the new law. Employers cannot simply ignore the tax treatment of employer-provided cell phones. Employers may consider implementing (if they have not already done so) one of the following policies:
- Limit an employee’s personal use of the cell phone to occasional personal use and exclude the personal use from the employee’s income as a de minimis fringe.
- Require employees to certify that they will use the cell phone only for business purposes.
- Enforce a policy of no personal use of the employer-provided cell phone and possibly require the employees to show that they have another cell phone for personal use.
- Allow employees to use the cell phone for personal use on a limited basis, and include a specified dollar amount in the employee’s compensation each month related to the personal use.
- Require employees to provide substantiation of the business and personal use of the cell phone.
Hopefully, the IRS will issue guidance that will give employers a framework for minimizing or eliminating the amount of income employees must recognize for employer-provided cell phones. Until guidance is issued, employers should take steps to ensure that their cell phone policies comply with existing tax law.
Greg Fairbanks is a tax senior manager with Grant Thornton LLP in Washington, DC.
For additional information about these items, contact Mr. Fairbanks at (202) 521-1503 or firstname.lastname@example.org.
Unless otherwise noted, contributors are members of or associated with Grant Thornton LLP.