Tax-Free Treatment of Cell Phones, Without the Burdensome Recordkeeping

It is fairly common for employers to provide employees with cell phones or to reimburse employees for the business use of their personal cell phones. Until recently, properly receiving favorable tax treatment for such employer-provided cell phones and reimbursements required burdensome recordkeeping. IRS Notice 2011-72 and an accompanying Field Examiner Memorandum provide welcome relief from the recordkeeping requirements, retroactive to taxable years beginning after December 31, 2009. The Notice and Memo also provide employers with clear instructions on how to avoid taxing employees on the value of employer-provided cell phones and reimbursements.

Past: Onerous Recordkeeping Requirements

In the bad old days cell phones were categorized as listed property, meaning that to qualify as a tax-free fringe benefit the use of the phone would have had to: (1) relate to the employer’s business; (2) entitle the employee to an income tax deduction if bought personally; and (3) be substantiated with records. The rigid substantiation requirements obligated employees to keep a record of all business calls and even specify the business purpose of each call. As a result, many companies established complex (and often convoluted) policies attempting to address employee cell phone use. Clearly, the general recordkeeping requirements for listed property were not compatible with modern cell phone utilization.

Present: Recordkeeping Relief

The Small Business Jobs Act of 2010 removed cell phones from the category of listed property for taxable years beginning after December 31, 2009, but questions regarding the proper tax treatment of employer-provided cell phones and cell phone reimbursements remained. On September 14, 2011, the IRS issued Notice 2011-72 and a corresponding Field Examiner Memorandum, which together clear up any remaining ambiguities.

Notice 2011-72 provides that a cell phone furnished primarily for noncompensatory business reasons is excludible from an employee’s income as a working condition fringe benefit and that the Code’s otherwise applicable substantiation requirements are deemed to be satisfied. Also, the IRS will treat the value of any personal use of the cell phone as an excludible de minimis fringe benefit. “Noncompensatory business reasons” means substantial reasons relating to the employer’s business, other than providing compensation to the employee, including: (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 outside the employee’s normal work day.

The Examination Memo addresses the treatment of reimbursements received by an employee from his or her employer for the business use of the employee’s personal cell phone. It provides that such reimbursements are not taxable if: (1) the employer, for substantial noncompensatory business reasons, requires the employee to maintain and use his or her personal cell phone for business purposes; (2) the type of cell phone plan is reasonably related to the needs of the employer’s business (for example, it’s not an international plan when only a local one is needed to service clients); (3) the reimbursement does not exceed expenses actually incurred in maintaining the phone; and (4) the reimbursement does not serve as a substitute for a portion of the employee’s regular wages.

Together the Notice and Memo provide that as long as a cell phone is furnished primarily for noncompensatory business reasons, the entire use of the cell phone is non-taxable to the employee and the full value of the benefit should be deductible for the employer. Employers and employees should note, however, that cell phones and personal cell phone use that is not primarily for business purposes remains taxable.

Andreea Sabin is a first year Associate at Verrill Dana. Andreea has recently passed the Maine bar exam and is eagerly awaiting admission.