Previously published in the AICPA Tax Insider
The IRS has announced guidance on the tax treatment of employer provided cellphones and employer reimbursements for personal cellphones.
Recently the Internal Revenue Service (IRS) issued guidance in the form of Notice 2011-72 that provided when an employer provides an employee a cellphone or other similar telecommunications equipment primarily for non-compensatory business reasons, the personal use and business use of the cellphone is generally not taxable to the employee. The icing on the cake is that the IRS will not require recordkeeping of business use in order to receive the tax free treatment. To fully understand the importance of the notice and realize how burdensome it was previously to avoid taxation to the employee, we must back up to when cellphones were "listed property" requiring strict substantiation.
Background
Generally, gross income includes compensation for services, including fringe benefits, which the employee's employer provides. However, gross income does not include any fringe benefit that qualifies as a working condition fringe benefit. That term is defined in code section 132(d) as "any property or services provided to an employee of the employer to the extent that, if the employee paid for such property or services, such payment would be allowable as a deduction under code section 162." The regulations provide that if, under code section 274 or any other section of the code, certain substantiation requirements must be met in order for a deduction under code section 162 to be allowable, then those substantiation requirements must be met in determining whether the property or service is excludable as a working condition fringe. Under code section 274(d)(4), no deduction will be allowed with respect to any listed property, unless the taxpayer substantiates via adequate records or through sufficient evidence corroborating the taxpayer's own statement:
- The amount of such expense or other item,
- The use of the property,
- The business purpose of the expense or other item and
- The business relationship to the taxpayer of persons using the property.
The Tax Reform Act of 1984 added special rules for "listed property" i.e. business property that was prone to personal use. Cellphones and "similar telecommunications equipment" were added to the category of listed property by the Revenue Reconciliation Act of 1989. As a result, the use of cellphones was subject to the strict recordkeeping requirements in order to be deductible. Further, strict recordkeeping was relevant in determining whether an employee's use of employer-provided property could be excluded as a working condition fringe benefit. Consequently, the strict recordkeeping requirement is crucial for the allowance of a proper deduction for any employer and to avoid additional income to an employee using the employer-provided property.
In response to increasing pressure from businesses feeling burdened by the strict reporting requirements with respect to employer-provided cellphones, President Obama's fiscal 2011 budget proposal called for the removal of cellphones from the listed property designation. After a number of House bills to remove cellphones from the designation of listed property stalled in the Senate because they contained controversial provisions, the Small Business Jobs Act of 2010 was passed and the president signed it into law on September 27, 2010. That act removed cellphones from the definition of listed property and the onerous recordkeeping provisions that apply to listed property. At the time, lobbyists hoped that the Treasury would confirm that employer-provided cellphones were a de minimis fringe benefit that was not subject to any reporting requirements.
Notice 2011-72
On September 14, 2011, the IRS issued Notice 2011-72 to provide guidance on the treatment of employer-provided cellphones or other similar telecommunications equipment as an excludible working condition fringe benefit. For taxable years after December 31, 2009, the IRS will treat an employee's business use and personal use of an employer-provided cellphone or other similar telecommunications equipment, provided for non-compensatory reasons related to the employer's trade or business, as a working condition fringe benefit, generally nontaxable to the employee.
The notice provides a number of examples of non-compensatory business reasons for the cellphone to be nontaxable, such as:
- The employer's need to contact the employee for work related matters;
- The employer's requirement that the employee when out of the office be available to talk to clients; and
- The employee's availability to speak to clients located in other time zones outside the normal work day.
On the other hand, the provision of a cellphone to promote the morale or goodwill of an employee, or to attract prospective employees or to furnish additional compensation to an employee is not considered a non-compensatory business purpose.
The notice provides that when a cellphone is provided to an employee for non-compensatory business purposes, the employee's use of the cellphone will be treated as a working-condition fringe benefit excludable from the income of the employee. In addition, the substantiation requirements that the employee would have to meet for a deduction under code section 162 will be deemed to be satisfied.
There are still a number of remaining questions. What if the cellphone is provided with a bundle of services, e.g. voice and data, and only one of the services is necessary for business reasons? Does the notice apply to the provision of a Wi-Fi only tablet device and do substantial business reasons exist for the employee to have the device? The IRS could determine that such a device is more akin to a laptop, and therefore subject to the substantiation requirements. Further, what if the tablet has 3G or 4G capability only? Does that capability make the tablet more like other similar telecommunications equipment? The notice appears to apply only to the provision of a cellphone or other similar telecommunications equipment, rather than to the reimbursement of the employee for such personally owned devices. The answers to these questions will depend upon how the IRS interprets "other similar telecommunications equipment."
Memorandum SBSE-04-0911-083
Simultaneously with the issuance of the notice, the IRS Memorandum SBSE-04-0911-083 issued to its examiners that contained a similar administrative approach to cash allowances or reimbursements for work-related use of personally owned cellphones. Although the approach is similar to the notice in determining non-compensatory business reasons, the memo provides additional specifications for reimbursements. Those additional specifications are that the type of cellphone coverage must be related to the business needs of the employer and the reimbursement must be reasonably calculated so as not to exceed the employee's costs. Overall, the reimbursement must not be a substitute for a portion of the employee's regular wages and must not be an arrangement that replaces a portion of the employee's previous wages. Also, examiners are cautioned to examine more closely reimbursement arrangements that allow for reimbursement of unusual or excessive expenses. As examples of unusual or excessive expenses, the memo lists reimbursement for international or satellite cellphone coverage in which the employer's customers are all in the local geographic area or in which the reimbursements deviate significantly from the normal course of cellphone use in the employer's business.
As in the notice there are a number of unanswered questions. The memo appears to apply only to reimbursements or cash allowances for personally owned cellphones and does not include any reference to "other similar telecommunications equipment." This presents the question of whether the memo covers reimbursement for non-voice e-mail or Internet service of a personally owned telecommunication device.
Conclusion
What is clear from the notice and memo is that the personal use and business use of employer-provided cellphones that an employer provides for non-compensatory business reasons or the reimbursement for personally owned cellphones used for business and personal reasons will not be taxable to the employee and that the employee is relieved from the substantiation requirements. We will have to wait and see whether employer-provided Wi-Fi tablet devices or the reimbursement for such devices will fall within either the notice or the memo.
Thomas R. Wechter, JD, LLM (Tax), is a partner with Duane Morris LLP in the Chicagooffice and concentrates his practice in taxplanning for individuals, corporations and partnerships and in tax controversy matters in front of the IRS and before the Tax Court, U.S. Court of Federal Claims and the District Courts.
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