On September 14, 2011, the Internal Revenue Service (the “IRS”) issued Notice 2011-72, 2011-38 IRB 407 which provides guidelines on the treatment of cellular telephones or other similar telecommunications equipment (hereinafter collectively “cell phones”) that employers provide to their employees primarily for business purposes.
Generally, Notice 2011-72 provides that, when an employer provides an employee with a cell phone primarily for “non-compensatory business reasons”, the IRS will treat (1) the employee’s use of the cell phone for reasons related to the employer’s trade or business (i.e., business use) as a working condition fringe benefit (the value of which is excluded from the employee’s income); and (2) the employee’s personal use of the cell phone is excluded from the employee’s income as a de minimis fringe benefit. Further, the Notice reduces the substantiation requirements necessary to achieve this favorable tax treatment.
In order to put this Notice in perspective, a brief review of the taxation of employer provided cell phones is helpful. In August 2009, the IRS released Notice 2009-46, 2009-23 IRB 1068, which (1) held that to the extent the employee uses the employer’s cell phone for personal purposes, the fair market value of such usage is includable in the employee’s gross income; and (2) requested comments on approaches to modifying and simplifying the substantiation requirements applicable to employee usage of employer-provided cell phones.
In August 2009, cell phones were “listed property” within the meaning of Section 280F of the Internal Revenue Code of 1986, as amended (the “Code”). Section 274(d)(4) of the Code provides that no deduction shall be allowed with respect to any listed property (as defined in Section 280F(d)(4)), unless the taxpayer substantiates by adequate records or by sufficient evidence corroborating the taxpayer’s own statement (A) the amount of such expense or other item, (B) the use of the property, (C) the business purpose of the expense or other item, and (D) the business relationship to the taxpayer of persons using the property.
These substantiation requirements made it problematic for employers to provide cell phones to their employees because (1) documenting the business purpose of each telephone call was burdensome, and (2) a portion of such employee’s cell phone use (i.e., the personal use) was taxable to the employee.
In September 2010, Congress adopted the Small Business Jobs Act of 2010 (the “Act”). Section 2043(a) of the Act removed cell phones from “listed property” thereby reducing the substantiation requirements for the employer’s deduction and for an employee’s exclusion of the imputed income from gross income as a fringe benefit. Further, the Committee Reports indicate the Act does not affect the IRS’s authority to determine (1) the appropriate characterization of cell phones as a “working condition fringe benefit” under Section 132(d) of the Code; or (2) that the personal use of cell phones that are provided primarily for business purposes may qualify as a de minimis fringe benefit under Section 132(a)(4) of the Code.
With the passage of the Act, an employer providing cell phones to its employees was still faced with the issue as to what information was required to be retained to document the satisfaction of the lower substantiation requirements (i.e., substantiate business use). Further, as described below, the personal use of employer provided cell phones did not fit neatly into the rules applicable to de minimis fringe benefits under Section 132(a)(4) of the Code.
Section 132(a)(4) of the Code provides that gross income does not include any fringe benefit which qualifies as a de minimis fringe benefit. Section 132(e) of the Code defines a de minimis fringe benefit as any property or service the value of which is (after taking into account the frequency with which similar fringes are provided by the employer to the employer’s employees) so small as to make accounting for it unreasonable or administratively impracticable.
Prior to Notice 2011-72, employers were often uncomfortable taking the position that the personal use of employer provided cell phones was so infrequent and of such small value as to make accounting for it administratively impracticable. Further, in some cases, the employers did not have sufficient information or the capability to determine the value of the employee’s personal use of employer provided cell phones. As such, employers were often faced with the options of (1) not providing cell phones to their employees; or (2) providing cell phones with the recognition that there was a risk that the IRS would attempt to tax the employee’s personal use of the cell phone (with a potential withholding and employment tax liability to the employer).
Notice 2011-72 addresses both of the above-described concerns relating to employer provided cell phones (i.e., substantiation for Section 132(d) purposes and the exclusion from income of personal use as a de minimis fringe benefit).
Basically, in the Notice 2011-72, the IRS provides that, if the employer provides the employee with a cell phone primarily for non-compensatory business purposes, (discussed below) (1) the employee’s business use of the cell phone is not taxable to the employee as a working condition fringe (Section 132(d) of the Code); (2) the substantiation requirements for purposes of Section 132(d) of the Code are deemed satisfied; and (3) the employee’s personal use of the cell phone is not taxable to the employee as a de minimis fringe benefit.
Notice 2011-72 provides that an employer will be considered to have provided an employee with a cell phone primarily for noncompensatory business purposes if there are substantial reasons relating to the employer’s business (i.e., noncompensatory business purposes) for providing the employee with a cell phone. The Notice indicates that non-compensatory business purposes include: (1) the employer’s need to contact the employee at all times for work-related emergencies; (2) the employer’s requirement that the employee be available to speak with clients at times when the employee is away from the office; and (3) the employee’s need to speak with clients located in other time zones at times outside of the employee’s normal work day.
The Notice notes that the following are not noncompensatory business purposes: (1) a cell phone provided to promote the morale or good will of an employee; (2) to attract a prospective employee; or (3) as a means of furnishing additional compensation to an employee.
In effect, the IRS has replaced a substantiation requirement that was very difficult to apply with a requirement that the employer document that the cell phone is provided to the employee for substantial business reasons (other than compensation). This all or nothing rule (100% deductible and 100% excludable from income if the condition is satisfied) is preferable to the former rule of trying to allocate between business use and personal use and then determine whether personal use was de minimis.
The rules of Notice 2011-72 apply to any use of an employer provided cell phone occurring after December 31, 2009.
Although Notice 2011-72 does not address situations where the employer reimburses the employee for all or a portion of the cost of the cell phone, the IRS released a memorandum to field examination operations, on September 14, 2011, which provides guidance to examiners and applies similar rules to reimbursement arrangements. Significantly, the memorandum provides the following example of an appropriate cell phone reimbursement arrangement.
An example of a reimbursement arrangement that does not result in additional income or wages is as follows: 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 tour of duty 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.
A full discussion of the rules applicable to employer reimbursement of employee cell phone expenditures is beyond the scope of this posting.
For employer’s currently providing cell phones to employees (and the employees who are provided cell phones), the Notice eliminates burdensome substantiation requirements and removes a potential audit issue (as to post-December 31, 2009 personal use). However, with the Notice, deductibility and income exclusion is now dependent on a noncompensatory business purpose supporting the employer’s provision of the cell phone to the employee. Consequently, employers should review the classes of employees who have been provided cell phones and document the business reasons for the provision of cell phones to such employees. Under these new rules, employers may need to cease to provide employer provided cell phones to some employees.
For employers currently reimbursing employees for cell phone expenses, the Notice and the memorandum suggest similar reduced substantiation requirements (business purpose rather than tracking business use) and a lower examination risk. However, these employers should review Notice 2011-72 and the IRS memorandum to determine whether their program is consistent with Notice 2011-72 (and the IRS Memorandum) and document the business reasons for the reimbursement of the employees’ cell phone expenses.
For employers not currently providing cell phones or reimbursing cell phone expenses, these employers may want to review their business operations to determine the desirability of adopting a compliant program to provide cell phones to appropriate employees or reimburse the appropriate employees’ cell phone expenses.
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