IRS: Cell Phone Services Provided to Employees Excludible from Income

Guidance Regarding Employer-Provided Cell Phones

Under new IRS guidance, Notice 2011-72, the value of the business use of employer-provided cell phone services that are provided for “noncompensatory business reasons” is excluded from the employees' income as a working condition fringe to the extent that the employees could claim a business deduction if they had paid for the cell phone services themselves.

The notice states that cell phone services provided to an employee are considered to be provided for noncompensatory business reasons if there are substantial reasons relating to the employer's business (other than providing compensation) for providing the employee with cell phone services. The notice gives the following examples of noncompensatory business reasons for furnishing cell phone services to employees:

• The employer needs to contact the employee at all times for work-related emergencies;
• The employee is required to be available to speak with clients at times when the employee is away from the office; and
• The employee needs to speak with clients in other time zones at times outside of the employee's normal work day.

Examples of cell phone usage that is not provided primarily for noncompensatory business reasons include when the employer provides the cell phone services:

• To promote the morale or good will of an employee;
• To attract a prospective employee, or
• As a means of furnishing additional compensation to an employee.

The new guidance asserts that, solely for purposes of determining whether the cell phone services are a working condition fringe benefit, the substantiation requirements that normally apply to such benefits are deemed to be satisfied when an employer provides employee cell phone usage primarily for noncompensatory business reasons. Additionally, the IRS will treat the value of any personal cell phone usage as provided by an employer primarily for noncompensatory business purposes as excludible from the employee's income as a de minimis fringe benefit. This treatment is effective for all tax years beginning after Dec. 31, 2009.

Employer Reimbursement for Employee's Business Use of Personal Cell Phone

The IRS also has provided guidance to examiners on the tax treatment of reimbursements in cases where employers, for substantial noncompensatory business reasons, require employees to maintain and use their personal cell phones for business purposes and reimburse the employees for such business use. In the past, questions have arisen as to what portion of the employer reimbursement might not be solely for business use and, therefore, constitute additional wages. The memorandum instructs the examiners in these cases to analyze the reimbursements in a manner that is consistent with the newly articulated approach for determining whether personal cell phone usage is a nontaxable de minimis fringe benefit. That is, examiners should not necessarily assert that the reimbursement results in additional income to the employee.

To avoid income to the employee, the type of cell phone coverage reimbursed must be reasonably related to the employer's business needs, and the reimbursement must be reasonably calculated. Furthermore, the reimbursement cannot be a substitute for regular wages. In addition, the guidance advises examiners to look more closely at arrangements allowing for reimbursement of unusual or excessive expenses.

In addition to the examples of noncompensatory business reasons, the new guidance includes some descriptions of favorable reimbursement arrangements that do not
result in additional income:

• An employer has a substantial noncompensatory business reason for requiring the employee to maintain a personal cell phone to facilitate communication with the employer's clients during hours outside the employee's normal workday in the office, and reimbursing the employee for the use of the phone.
• The employee uses the cell phone for both business purposes and personal purposes and the employee's basic coverage plan charges a flat-rate per month for a certain number of minutes for domestic calls.
• The employer reimburses the employee for the monthly basic plan expense to enable the employee to maintain contact with business clients throughout the United States after hours.

On the other hand, examples of reimbursement arrangements that may be in excess of the expenses reasonably related to the needs of the employer's business and should be examined more closely include:

• Reimbursement for international or satellite cell phone coverage to a service technician whose business clients and other business contacts are all in the local geographic area where the technician works.
• A pattern of reimbursements that deviates significantly from a normal course of cell phone use in the employer's business (e.g., an employee received reimbursements for cell phone use of $100/quarter in quarters one through three, but receives a reimbursement of $500 in quarter four).

Implications

The IRS guidance is generous, allowing employers to exclude 100% of the value of the use of employer-provided cell phone services from taxable wages if such services are furnished for business reasons primarily noncompensatory in nature. Further, the substantiation requirements are also deemed to be satisfied as to the reimbursement of the business use of a personal cell phone. Thus, tax-free treatment of employer-provided cell phone usage is available without extensive individual employee record-keeping.

The IRS guidance is not as clear-cut concerning the tax treatment of employer-provided cell phone allowances when an employee is using his or her personal cell phone for business reasons. Because the IRS guidance discusses the requirement that employer reimbursements be “reasonably calculated” and provided primarily for noncompensatory reasons, employers providing reimbursements will need to gather and maintain sufficient documentation to show that the reimbursements to employees are reasonable in light of an employee's job duties and the cost of the cell phone service plan.

Christa Bierma and Debera Salam are senior managers in the National Tax Department of Ernst & Young LLP. The views expressed in this article are those of the authors and do not necessarily represent the views of Ernst & Young LLP.

The IRS has modified its position on the tax treatment of cell phone services and similar telecommunications equipment usage (“cell phones”) that employers provide to employees primarily for noncompensatory business reasons. The value of the use of such cell phones ' a category that an IRS official has recently suggested may include tablet devices ' is now excludible from employees' income as a working condition fringe. In addition, the personal use of such cell phones is also excludible from the employees' income.

As a general matter, gross income includes fringe benefits unless they are specifically excluded. One of these exclusions is any fringe benefit that qualifies as a working condition fringe, meaning any property or services provided to an employee to the extent that, if the employee paid for such property or services, the payment would be allowable to the employee as a business deduction. A deduction is allowed for all the ordinary and necessary expenses paid or incurred during the tax year in carrying on any trade or business.

Special heightened substantiation rules apply in the case of certain “listed property.” Deductions are not permitted for any listed property unless the taxpayer substantiates the deduction by adequate records or by sufficient evidence, including records adequate to corroborate the amount of the expense, the time and place of the use of the property, the business purpose, and the business relationship to the property. Cell phones were removed from the definition of listed property for tax years beginning after Dec. 31, 2009. As a result, the heightened substantiation requirement no longer applies to cell phones. However, the legislation did not specifically address the extent to which the value of the personal use of an employer-provided cell phone must be included in the employee's gross income, or the potential treatment of the value of an employer-provided cell phone as an excludible working condition fringe benefit. As a result, there has been continuing uncertainty about the proper tax treatment of employer-provided cell phone services. New IRS guidance provides helpful clarification.

Guidance Regarding Employer-Provided Cell Phones

Under new IRS guidance, Notice 2011-72, the value of the business use of employer-provided cell phone services that are provided for “noncompensatory business reasons” is excluded from the employees' income as a working condition fringe to the extent that the employees could claim a business deduction if they had paid for the cell phone services themselves.

The notice states that cell phone services provided to an employee are considered to be provided for noncompensatory business reasons if there are substantial reasons relating to the employer's business (other than providing compensation) for providing the employee with cell phone services. The notice gives the following examples of noncompensatory business reasons for furnishing cell phone services to employees:

• The employer needs to contact the employee at all times for work-related emergencies;
• The employee is required to be available to speak with clients at times when the employee is away from the office; and
• The employee needs to speak with clients in other time zones at times outside of the employee's normal work day.

Examples of cell phone usage that is not provided primarily for noncompensatory business reasons include when the employer provides the cell phone services:

• To promote the morale or good will of an employee;
• To attract a prospective employee, or
• As a means of furnishing additional compensation to an employee.

The new guidance asserts that, solely for purposes of determining whether the cell phone services are a working condition fringe benefit, the substantiation requirements that normally apply to such benefits are deemed to be satisfied when an employer provides employee cell phone usage primarily for noncompensatory business reasons. Additionally, the IRS will treat the value of any personal cell phone usage as provided by an employer primarily for noncompensatory business purposes as excludible from the employee's income as a de minimis fringe benefit. This treatment is effective for all tax years beginning after Dec. 31, 2009.

Employer Reimbursement for Employee's Business Use of Personal Cell Phone

The IRS also has provided guidance to examiners on the tax treatment of reimbursements in cases where employers, for substantial noncompensatory business reasons, require employees to maintain and use their personal cell phones for business purposes and reimburse the employees for such business use. In the past, questions have arisen as to what portion of the employer reimbursement might not be solely for business use and, therefore, constitute additional wages. The memorandum instructs the examiners in these cases to analyze the reimbursements in a manner that is consistent with the newly articulated approach for determining whether personal cell phone usage is a nontaxable de minimis fringe benefit. That is, examiners should not necessarily assert that the reimbursement results in additional income to the employee.

To avoid income to the employee, the type of cell phone coverage reimbursed must be reasonably related to the employer's business needs, and the reimbursement must be reasonably calculated. Furthermore, the reimbursement cannot be a substitute for regular wages. In addition, the guidance advises examiners to look more closely at arrangements allowing for reimbursement of unusual or excessive expenses.

In addition to the examples of noncompensatory business reasons, the new guidance includes some descriptions of favorable reimbursement arrangements that do not
result in additional income:

• An employer has a substantial noncompensatory business reason for requiring the employee to maintain a personal cell phone to facilitate communication with the employer's clients during hours outside the employee's normal workday in the office, and reimbursing the employee for the use of the phone.
• The employee uses the cell phone for both business purposes and personal purposes and the employee's basic coverage plan charges a flat-rate per month for a certain number of minutes for domestic calls.
• The employer reimburses the employee for the monthly basic plan expense to enable the employee to maintain contact with business clients throughout the United States after hours.

On the other hand, examples of reimbursement arrangements that may be in excess of the expenses reasonably related to the needs of the employer's business and should be examined more closely include:

• Reimbursement for international or satellite cell phone coverage to a service technician whose business clients and other business contacts are all in the local geographic area where the technician works.
• A pattern of reimbursements that deviates significantly from a normal course of cell phone use in the employer's business (e.g., an employee received reimbursements for cell phone use of $100/quarter in quarters one through three, but receives a reimbursement of $500 in quarter four).

Implications

The IRS guidance is generous, allowing employers to exclude 100% of the value of the use of employer-provided cell phone services from taxable wages if such services are furnished for business reasons primarily noncompensatory in nature. Further, the substantiation requirements are also deemed to be satisfied as to the reimbursement of the business use of a personal cell phone. Thus, tax-free treatment of employer-provided cell phone usage is available without extensive individual employee record-keeping.

The IRS guidance is not as clear-cut concerning the tax treatment of employer-provided cell phone allowances when an employee is using his or her personal cell phone for business reasons. Because the IRS guidance discusses the requirement that employer reimbursements be “reasonably calculated” and provided primarily for noncompensatory reasons, employers providing reimbursements will need to gather and maintain sufficient documentation to show that the reimbursements to employees are reasonable in light of an employee's job duties and the cost of the cell phone service plan.

Christa Bierma and Debera Salam are senior managers in the National Tax Department of Ernst & Young LLP. The views expressed in this article are those of the authors and do not necessarily represent the views of Ernst & Young LLP.