A working condition fringe benefit is property or services provided to an employee that meets all three of the following requirements: (a) an employee who had personally incurred the cost could have deducted the property or service as a trade or business expense or as a depreciable asset; (b) the employee’s use of the property or service is substantiated by adequate records or sufficient evidence corroborating the employee’s own statement; and (c) the employee’s use of the property or service is related to the employer's trade or business [IRC Sec. 132(d); Reg. 1.132-5(a)(1) and (2)].
Expenses for travel (e.g., meals and lodging), transportation, entertainment, and listed property must satisfy special substantiation requirements. Under IRC Sec. 274(d), no deduction is allowed unless the amount, time and place (or date and use), business purpose, and business relationship are properly substantiated. Expenses not governed by IRC Sec. 274(d) are subject to less stringent substantiation requirements under Reg. 1.162-17, which include providing sufficient substantiation and documentation to show that the expenses were paid or incurred and that they constitute ordinary and necessary business expenses.
Before 2010, cell phones and similar telecommunications equipment were listed property under IRC Sec. 280F(d)(4)(A). In response to complaints that this treatment was unreasonable, the Small Business Jobs Act of 2010 removed cell phones and similar telecommunications equipment from the definition of listed property for tax years beginning after December 31, 2009. Therefore, the heightened substantiation requirements that apply to listed property no longer apply to cell phones.
IRS Issues Clarifying Guidance
On September 14, 2011, the IRS issued guidance clarifying the tax treatment of employer-provided cell phones. A notice provides guidance on the treatment of employer-provided cell phones as an excludible fringe benefit, while a memo to IRS examiners addresses the treatment of cash allowances and reimbursements for work-related use of personally-owned cell phones. Where employers provide cell phones to their employees or where employers reimburse employees for the business use of their personal cell phones, tax-free treatment is available without having to meet the burdensome Section 274(d) recordkeeping requirements.
Employer-provided Cell Phones
According to Notice 2011-72 (2011-38 IRB), an employer will be considered to have provided an employee with a cell phone primarily for noncompensatory business purposes if there are substantial business reasons (other than compensating the employee) for providing the phone. For example, the employer’s need to contact the employee at any time for work-related emergencies, the employer’s requirement that the employee be available to speak with clients when the employee is away from the office, and the employee’s need to speak with clients located in other time zones outside of the employee’s normal work day are possible substantial noncompensatory business reasons.
On the other hand, a cell phone provided to promote the morale of an employee or to attract a prospective employee is not provided primarily for noncompensatory business purposes.
When an employer provides an employee with a cell phone primarily for noncompensatory business reasons, the IRS will treat the employee’s use of the cell phone as a working condition fringe benefit that is excludable from the employee’s income. And solely for determining whether the working condition fringe benefit rule applies, the substantiation requirements that the employee would have to meet under IRC Sec. 162 are deemed to be satisfied. In addition, the IRS will treat the value of any personal use of a cell phone provided by the employer primarily for noncompensatory business purposes as excludable from the employee’s income as a de minimis fringe benefit.
These rules apply to any use of an employer-provided cell phone occurring after December 31, 2009. The application of the working condition and de minimis fringe benefit exclusions under this notice apply ONLY to employer-provided cell phones—not to other employer-provided property or services.
Reimbursement of Employee Personal Cell Phone
Notice 2011-72 does not address reimbursements paid to employees by employers for the business use of their personal cell phone. However, a September 14, 2011 memo to IRS examiners (SBSE-04-0911-083) provides audit guidance on this issue.
When employers require employees to maintain and use their personal cell phones for business purposes and reimburse the employees for the business use of their personal cell phones, examiners should analyze the reimbursements by following the approach in Notice 2011-72. If employers have substantial business reasons (other than providing compensation to the employees) for requiring the use of personal cell phones and reimbursing employees for their use, examiners should not assert that the employer’s reimbursement results in additional income or wages to the employee.
However, the employee must maintain cell phone coverage that reasonably meets the employer’s business needs, and the reimbursement must be reasonably calculated not to exceed the cell phone expenses actually incurred by the employee. Furthermore, the reimbursement for business use of the employee’s personal cell phone must not be a substitute for the employee’s regular wages.
As in Notice 2011-72, examples of substantial noncompensatory business reasons for requiring employees to maintain personal cell phones and reimbursing them for their use include the employer’s need to contact the employee at all times for work-related emergencies, and the employer’s requirement that the employee be available to speak with clients while away from the office or outside of the employee’s normal work day.
For example, assume that the employee uses the cell phone for both business purposes and personal purposes and the employee’s 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 country after hours. The memo concludes that this reimbursement arrangement would not result in additional income to the employee.
On the other hand, examples of reimbursement arrangements that should be examined more closely include: (1) reimbursement for international or satellite cell phone coverage to an employee whose business clients and other business contacts are in the local area; or (2) a pattern of reimbursements that deviates from a normal course of cell phone use, such as the reimbursement of cell phone use at $100 per quarter in the first three quarters of the year, but a $500 for the last quarter of the year.
The Small Business Jobs Act of 2010 did not remove personal computers from the definition of listed property. Therefore, computers are listed property unless they are used solely for business at a regular business establishment, which includes a qualifying home office. Since a computer used solely for business in a qualifying home office is not listed property, a tax return that includes a computer as listed property generally should not also include a home office deduction (unless, for example, the computer is kept somewhere other than the home office).