It used to be that employees who were given company-paid cell phones or were reimbursed for use of their personal cell phone had a taxable fringe benefit; the amount was determined by the employer. After all, employees could use these phones to call their family or friends, which is clearly personal and not for business. Figuring out the amount of this benefit was a headache for employers.
All this changed last year when the Small Business Jobs Act eliminated cell phones from the category of “listed property” in the tax law. By “delisting” cell phones, onerous substantiation requirements were eliminated and the ability to offer cell phones as tax-free benefits was made much easier. Here’s where things stand now when it comes to employer-provided cell phones (including smart phones).
Phones given for business purposes
If an employer gives a cell phone to an employee for a “noncompensatory business purpose” (i.e., not merely as a reward for services), then the value of using the phone is not taxable to the employee. It is treated as a “working condition fringe benefit” because the employee could have deducted the phone if he or she had paid for it.
Under recent IRS guidance, each of the following situations is viewed as having a “noncompensatory business purpose” so that the cell phone is not taxed to the employee:
- The employer needs to contact the employee at all times for any work-related emergencies.
- The employer requires the employee to be available to speak with clients and customers at all times when the employee is away from the office.
- The employee needs to speak with clients located in other time zones at times outside of the employee’s normal work hours.
If the employer doesn’t provide the cell phone but instead has a reimbursement arrangement to cover the employee’s cost of his or her personal cell phone used for business, this too can be treated as a noncompensatory business purpose. The reimbursement amount must be limited to the cell phone charges; any excess reimbursements to the employee must be returned to the employer or it becomes taxable.
Once this business purpose is established, any personal use of an employer-provided phone is also tax free. It is viewed as a de minimis fringe benefit, meaning that its value is so small it isn’t worth bothering with.
Employees taxed on cell phones
If there is no noncompensatory business reason, then the employer will figure the value of the use to the employee and include this amount on the employee’s W-2 form. The IRS provides several examples of a cell phone that is not provided primarily for a noncompensatory business reason:
- Good will or morale of an employee.
- Attracting a prospective employee.
- Providing additional compensation.
- Reimbursement or payment for international coverage for a service technician with only local clients or customers.
The IRS has told its examiners auditing company returns to look for reimbursement arrangements that deviate from what would appear to be normal cell phone usage. The IRS gives this example: If an employer reimburses an employee $100 per quarter for the first three quarters of the year and then reimburses the employee $500 in the last quarter, it raises the question of whether that additional $400 in the last quarter is disguised compensation that should be taxed to the employee.
An employer should work within the IRS guidance to ensure that any cell phone it gives to an employee or any reimbursement arrangement for cell phone usage does not go beyond the tax-free bounds. If it does, it will create a burden for both the employer and the employee. The employer will have to figure the taxable fringe benefit and pay employment taxes on this amount; the employee will have the fringe benefit added to ordinary compensation and it will be taxable. It may make sense to consult with a tax advisor to ensure that you are doing things right!