Recently, the Internal Revenue Service (IRS) issued Notice 2011‑72 and a Field Examination Memorandum dated September 14, 2011, giving tax relief to employees whose employers provide them with cell phones or reimbursement of cell phone charges.
Under the Notice, the IRS will treat an employee's use of an employer-provided cell phone issued for a reason related to the employer's trade or business as a "working condition fringe benefit" under Code Section 132(e). Under that Code section and accompanying regulations, employee business expenses that would otherwise be deductible by the employee need not be included in the employee's taxable income. More importantly, if the employer can demonstrate that the phone was issued primarily for a non-compensatory business purpose, the substantiation requirements of the Code are deemed to be satisfied. In other words, the employee would not need to track (by minutes or calls) business versus personal use. As a result, the IRS notice indicates that the personal use would be excluded from taxable income as a "de minimus fringe benefit" under Code Section 132(e). Accordingly, no tracking of personal use would be required.
The Notice provides certain examples of how an employer could show, if under examination, that the employee's phone is primarily for a business use, such as the employer's need to contact the employee for work-related emergencies or a requirement of the job that the employee be able to speak with clients while away from the principal place of business. According to the Notice, this tax treatment is to apply to use of cell phones and other similar telecommunications equipment used after December 31, 2009.
The Field Examination Memorandum directs IRS tax auditors to apply the same rationale of Notice 2011‑72 to employee reimbursement arrangements where the employee purchases and maintains the cell phone or personal digital assistant (PDA) and the employer reimburses the employee's business use. Examiners are directed to allow reimbursement of cell phone charges that are "reasonably related to the needs of the employer's business" so long as the reimbursement is "reasonably…calculated so as not to exceed the expenses the employee actually incurred in maintaining the cell phone." The Memorandum, however, does not allow employers to substitute employees' previous wages with tax-free cell phone allowances, preventing employers from offering a cafeteria-type salary reduction for cell phone benefits. The Memorandum provides examples of reimbursement arrangements that may exceed the allowable tax-free amount, such as a reimbursement for international or satellite-zone cell phone coverage where the business clients are all in a local geographic area or a pattern of irregular reimbursements in a particular month or quarter that exceeds the average reimbursements in prior periods. These situations would continue to result in some taxable income to the employee.
The Notice and Field Examination Memorandum evidence a common sense tax enforcement policy. The prior personal/business use substantiation rules placed an unreasonable burden on small businesses and workers. The Obama Administration has pledged to examine and consider repeal of existing federal regulations impacting small businesses that might stunt the creation of jobs and growth. This new regulatory interpretation is certainly a step in the right direction toward fulfilling that pledge.