IRS Cell Phone Rules Debate Waste of Taxpayers’ Time and Money

By Ron Cohen, CPA, MST
Partner
Greenstein, Rogoff, Olsen & Co., LLP

UPDATE: January 12, 2010

IRS Puts Cell Phone Proposal on Hold

WASHINGTON, D.C.
(JANUARY 11, 2010)

BY WEBCPA STAFF

Internal Revenue Service Commissioner Doug Shulman has decided against coming up with rules on the taxation of employer-provided cell phones and said the IRS would instead wait for congressional legislation.

In June, Shulman and Treasury Secretary Tim Geithner encouraged Congress to pass legislation that would end the tax on personal use of employer-provided cell phones (see Shulman, Geithner Call for End to Cell Phone Use Tax). Earlier that month, the IRS asked for comments on the best ways to simplify compliance with rules related to employer-provided cell phones.

The IRS has proposed taxing up to 25 percent of employees’ use of the phones but has encountered stiff opposition from the cell phone industry. However, Shulman indicated in an interview with C-SPAN’s “Newsmaker” show last Friday that he prefers to let Congress settle the question.

“We’re quite hopeful Congress is going to act on this,” he said, according to Dow Jones Newswires. “In the meantime, we’re not doing anything special or moving forward with any initiatives. Our hope is that there will be legislation to clean this up.”

In 1989, cell phones were designated as “listed property” under the Tax Code, and are therefore subject to special recordkeeping requirements to establish their business use. Companies and employees have long complained about the onerous recordkeeping requirements, and many companies simply ignore them.

Rep. Sam Johnson, R-Texas, has introduced a bill, H.R. 690, the Mobile Cell Phone Act, to update the treatment of cell phones and BlackBerries used for business and repeal the requirement that employers and employees maintain detailed logs of cell phone use. The bill was approved by the House during the last Congress, but is still in committee in the current session.

UPDATE:  June 16, 2009:

Perhaps President Obama called the Commissioner and expressed anger about his need to pay income tax on his employer-provided cell phone calls to the First Lady?

The IRS triggered so much bad press and anger (Wall Street Journal, Washington Post, LA Times articles) over this Cell Phone issue, that the IRS Commissioner took the unusual action of issuing a Statement.  As you can read below, it “spins” the issue and then asks Congress for help by passing new laws.

We agree, overall.  The IRS has a duty to enforce the laws on the books.  Bad laws make for bad enforcement.  We completely sympathize with the IRS on this point.  Perhaps the Commissioner should have, as he has now,  asked for a legislative fix rather than issue last week’s notice suggesting ridiculous solutions.

We disagree with the Commissioner’s comment that:  “Some have incorrectly implied that the IRS is "cracking down" on employee use of employer-provided cell phones. To the contrary, the IRS is attempting to simplify the rules and eliminate uncertainty for businesses and individuals.”

When a law is not enforced for years (because reasonable people – including IRS agents --  have concluded it is silly), and then the IRS starts to enforce it (University of California forced to pay $250K of payroll taxes for employee cell phone use), that IS a “crackdown”, or, at the least a change in internal policy.  Further, clarifying the rules, while perhaps helpful to taxpayers to further define this silliness,  would – which is their real agenda -- provide the IRS clarity and a roadmap for their agents to quickly pick-off an assessment for 25% of total cell phone use as taxable personal use, if one of their proposals was implemented.   The Commissioner will have to excuse us for always assuming the worst about their motives…but it comes from experience.

But, OK… let’s not question the Commissioner’s good intensions, because his last paragraph is a righteous and complete capitulation: “Therefore, Secretary Geithner and I ask that Congress act to make clear that there will be no tax consequence to employers or employees for personal use of work-related devices such as cell phones provided by employers. The passage of time, advances in technology, and the nature of communication in the modern workplace have rendered this law obsolete.”

Statement of IRS Commissioner Doug Shulman

Although some of the proposed changes would add clarity, the current law will inevitably leave widespread confusion among employees and businesses. Therefore, Secretary Geithner and I ask that Congress act to make clear that there will be no tax consequence to employers or employees for personal use of work-related devices such as cell phones provided by employers. The passage of time, advances in technology, and the nature of communication in the modern workplace have rendered this law obsolete.

http://www.irs.gov/newsroom/article/0,,id=209795,00.html

Original Blog of June 8, 2009:

Treatment of Employer-Provided Cell Phones

In the scheme of the country’s problems at this time in history, the IRS feels the need to further clarify the treatment of employer-provided cell phones.

Unfortunately, years ago, cell phones were designated as “Listed Property” and therefore, the taxpayer is required to maintain records to determine the portion of “business use” versus “personal use.”

I’m sure you have the same reaction I’ve had for years. The whole issue is absurd!

Perhaps when cell phones cost $2,000 each and the usage rates were over $1 a minute (back in the early 1990s, as I recall), these rules made some sense.

But in a world where the usage contracts are less than $100 per month (some, much less), and the phone is cheap or FREE with the contract, the mere idea of tracking the personal use versus business use is unreasonable, if not oppressive.

For example, let’s say, in the extreme, I make 1 business call a day on the cell phone, and as a direct result of those calls, I earn $1 million of income per year. Otherwise, I use the cell phone to call to my wife, my son, and order pizza. Say, 3 personal calls per day.

The usage contract for the cell phone is $100 per month. The cell phone itself cost my company $250 to purchase and I can also read my email on the phone – but let’s not even consider the email (should I split my emails between business and non-business email since I read them on my cell phone?….Ugh!).

Is the business use of that phone calculated as 1 business call out of a total of 4 calls or 25%? Or, is the value of having the phone to make the business calls to earn $1 million of income so disproportionally important compared to the minor convenience of making a few personal calls, that the “count the personal phone calls” approach is bizarre?

But, the IRS can’t figure out a, simple, common sense approach to this issue without public input.

May I suggest the following rule: “Just forget about it! If the employer deems the employee needs a cell phone for business use, the personal calls are hereby deemed too small to worry about.”

No company I know of would allow the employee to make excessive, costly non-business personal calls. They’d cut-off the employee’s phone. An internal accountant will review the cell phone bills for reasonableness.

Further, if an employee calls his sick Mother 20 times a day on his cell phone, in addition to his business calls, and there is no incremental cost for those personal calls under the fixed-price monthly usage contract, why should it matter?

If a few executives or business owners – where they control who gets an employer-provided cell phone -- make costly personal calls, there are already rules on the books limiting the employer’s tax deduction for personal and/or extravagant expenses.

No doubt, excessive personal cell phone bills should be treated as addition compensation and included in the abusers W-2 income.

But how many rules do we need to determine what is excessive? Do we as a society really need to work this issue to capture the last $5 per month of personal cell phone use?

I suggest we will spend $20 of economic cost (for accountants, forms, spreadsheets, computer programming, payroll input and analysis) to report that additional $5 of potential taxable income and collect less than $2 of tax thereon.

Sadly, instead, the IRS is seeking public feedback on various potential methods to analyze personal use, including a “Statistical Sampling Method.” Just in case an employer is not spending all their time trying to keep their business running, he can consider developing “ statistical sampling techniques to measure an employee’s personal use of an employer-provided cell phone.”

Sometimes the “Ivory Tower” nature of IRS proposals makes me laugh…and then cry.

BIG COMPANIES CONCEDE RATHER THAN ARGUE

I’m told many companies are imputing an amount of taxable income to their employees and adding it to the employees W-2 income. They are doing so, not because it is the correct value related to personal cell phone usage, but, rather, it is a rough over-estimate to avoid any challenge to their payroll tax returns, and further to avoid any challenge by financial auditors under FIN 48 of the GAAP rules. FIN 48 requires GAAP financial statements to record an estimated liability for possible unrecorded tax liabilities.

Rather than fight battles with financial auditors over the value of personal use of employer provided cell phones, and the possible unpaid payroll taxes, a company will over-estimate the personal use amount. That’s a costly shame. That means the employee is paying tax on phantom income just so that his employer can avoid unwarranted discussions... where, as I argue, the economic value to the employees of the use of the cell phone for personal calls is very close to zero. The economic value to a company to avoid having a challenge to their payroll tax returns and financial statements over a FIN 48 issue, however, is very high. So this becomes a matter of doing what is expedient rather than what is correct.

Does the IRS really expect the employee to keep a second cell phone on hand for personal calls? Should the employee keep a pocket full of quarters to use a pay phone, if you can even find one these days?

The whole exercise is related to the concept of income as defined by IRC Sec. 61 which includes both cash or property of any value received by the taxpayer. Again, with regard to personal cell phone use, I believe, in most cases, the Fair Market Value of personal calls is near zero.

I can always be reached for questions or comments at (510) 797-8661 x237.

Notice 2009-46

PURPOSE

This notice requests comments from the public regarding several proposals to simplify the procedures under which employers substantiate an employee’s business use of employer-provided cellular telephones or other similar telecommunications equipment (hereinafter collectively referred to as “cell phones”). This notice describes the proposals under consideration. The Internal Revenue Service (IRS) and Treasury Department are interested in considering other possible approaches. Therefore, this notice also requests suggestions for alternative approaches to simplify the procedures under which employers substantiate an employee’s business use of employer-provided cell phones.

Any changes to the substantiation procedures applicable to employer-provided cell phones will not become effective until the IRS and Treasury Department consider public comments and suggestions received in response to this notice and publish guidance announcing any simplified substantiation procedures.

BACKGROUND

Employers

Section 162(a) of the Internal Revenue Code provides that a deduction is allowed for all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business. However, § 262(a) provides that, except as otherwise expressly provided, no deduction shall be allowed for personal, living, or family expenses.

Section 274(d)(4) provides that no deduction shall be allowed with respect to any listed property (as defined in § 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. The Secretary may by regulations provide that some or all of the requirements of the preceding sentence shall not apply in the case of an expense that does not exceed an amount prescribed pursuant to such regulations.

Section 280F(d)(4)(A)(v) provides that “listed property” includes any cellular telephone (or other similar telecommunications equipment).

Section 1.274-5T(a) of the temporary Income Tax Regulations provides that no deduction or credit shall be allowed with respect to any listed property unless the taxpayer substantiates each element of the expenditure or use. Section 1.274-5T(b)(6) provides that the elements to be proved with respect to any listed property are:

(i) Amount — (A) The amount of each separate expenditure with respect to an item of listed property, such as the cost of acquisition, and (B) the amount of each business use based on the appropriate measure (that is, time) and the amount of total use of the listed property for the taxable period ( see § 1.274-5T(e)(2));

(ii) Time — The date of the expenditure or use with respect to the listed property; and

(iii) Business purpose — The business purpose for an expenditure or use with respect to any listed property.

Section 61(a)(1) provides that, except as otherwise provided, gross income includes compensation for services, including fees, commissions, fringe benefits, and similar items. Section 1.61-21(b)(1) of the Income Tax Regulations requires that an employee generally must include in gross income the amount by which the fair market value of a fringe benefit exceeds the sum of (i) the amount, if any, paid for the benefit by or on behalf of the employee, and (ii) the amount, if any, specifically excluded from gross income by some other section of the Code. The fair market value of a fringe benefit is the amount that an individual would have to pay for the particular fringe benefit in an arm’s length transaction. Section 1.61-21(b)(2). The cost incurred by an employer is not determinative of the fair market value of a fringe benefit. Id.

Section 132(a)(3) provides that gross income does not include any fringe benefit that qualifies as a working condition fringe. Section 132(d) provides that “working condition fringe” means 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 § 162 or § 167.

Section 1.132-5(a)(1)(ii) provides that if, under § 274 or any other section of the Code, certain substantiation requirements must be met in order for a deduction under § 162 or § 167 to be allowable, then those substantiation requirements apply in determining whether a property or service is excludable as a working condition fringe. See also § 1.132-5(c)(1). The substantiation requirements of § 274(d) are satisfied by adequate records or sufficient evidence corroborating the employee’s own statement. Section 1.132-5(c)(2). Therefore, such records or evidence provided by the employee, and relied upon by the employer to the extent permitted by the regulations promulgated under § 274(d), will be sufficient to substantiate a working condition fringe exclusion. Id.

If an employer provides a cell phone to an employee, and the employer acquires and pays the costs of using the cell phone, the employee receives a fringe benefit. To the extent that the employee uses the employer’s cell phone for business purposes, the fair market value of such usage qualifies as a working condition fringe benefit excludable from the employee’s gross income and the cell phone expense is a deductible business expense for the employer, provided that the substantiation requirements of § 274(d) are met. However, 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. The employer’s cost to provide the cell phone is not determinative of the fair market value of the benefit received by the employee.

The IRS and Treasury Department are considering the following proposals to simplify the § 274(d) substantiation requirements applicable to employee usage of employer-provided cell phones.

General Requirements

As discussed in greater detail below, the IRS and Treasury Department are considering three alternative methods to simplify the substantiation requirements applicable to employee usage of employer-provided cell phones: a minimal personal use method, a safe harbor substantiation method, and a statistical sampling method (or a combination of the foregoing). Any simplified cell phone substantiation method will be optional; taxpayers may continue to comply with current § 274(d) substantiation requirements.

The IRS and Treasury Department contemplate that any taxpayer who wishes to use a simplified cell phone substantiation method will be required to implement a written policy that requires employees to carry and use the employer-provided cell phones in connection with the employer’s trade or business and that prohibits personal use of employer-provided cell phones, except for minimal personal use, similar to the requirements currently applicable to employer-provided automobiles in § 1.274-6T. In addition, the IRS and Treasury Department anticipate requiring that the employer must reasonably believe that the cell phone is not used for personal purposes except for minimal personal use.

1. Minimal Personal Use Method

The IRS and Treasury Department are considering two proposals that would allow an employer to deem all of an employee’s usage of an employer-provided cell phone as business usage. Under the first proposal, the entire amount of an employee’s use of an employer-provided cell phone would be deemed to be for business purposes if the employee can account to his or her employer with sufficient records to establish that the employee maintains and uses a personal (non-employer-provided) cell phone for personal purposes during the employee’s work hours.

Alternatively, the second proposal would define a specified amount or type of “minimal” personal use that would be disregarded in determining the amount of personal use of an employer-provided cell phone. For example, “minimal” could be defined by reference to a particular number of minutes of use or for certain personal purposes.

2. Safe Harbor Substantiation Method

The IRS and Treasury Department are considering a safe harbor method under which an employer would treat a certain percentage of each employee’s use of an employer-provided cell phone as business usage. The remaining percentage of use would be deemed to be for personal purposes. For this proposal, the IRS and Treasury Department propose a business use percentage of 75 percent.

3. Statistical Sampling Method

The IRS and Treasury Department are considering a proposal that would allow employers to use statistical sampling techniques to measure an employee’s personal use of an employer-provided cell phone. In general, an employer could use an approved statistical sampling methodology similar to that provided in Rev. Proc. 2004-29, 2004-1 C.B. 918, to determine the percentage of personal use of employer-provided cell phones. The employer would multiply that percentage times the value of each employee’s total usage to determine the value of personal usage. The remaining portion of the employee’s usage would be deemed to be for business purposes.

To the extent that an employee’s use of an employer-provided cell phone does not qualify as a working condition fringe benefit (because the employer does not satisfy § 274(d) or the cell phone is used partially for personal purposes), the fair market value of an employee’s use of the employer-provided cell phone is a taxable fringe benefit that is includable in the employee’s gross income. An employer’s cost to provide the cell phone is not determinative of the fair market value of an employee’s fringe benefit. The IRS and Treasury Department are interested in understanding the methods employers currently use to arrive at the fair market value to an employee of an employer-provided cell phone. The IRS and Treasury Department are considering whether a simplified valuation method would be helpful and appropriate to determine such fair market value.