The IRS Releases New Contractor-Friendly Cell Phone Reimbursement Rules

By Todd Taggart & Ben Spector

On September 14, 2011, the IRS released new contractor-favorable guidance that will allow contractors and employees to exclude the value of employer-provided cell phones from employee income without burdensome documentation requirements. The IRS guidance includes 1) a notice and 2) an internal memo to IRS examiners, both of which were issued in the wake of a statutory change made by the Small Business Jobs Act of 2010.

The statutory change removed employer-provided cell phones from the definition of “listed property.”  Under tax law, contractors may not take a deduction for “listed property” unless the contractor can prove a business use. Prior to the new cell phone rules, all employees using employer-provided cell phones needed to prove that they were using their phones for business to receive an expense reimbursement, and then include the value of their personal use in their income. The requirements for proving business use were extensive and burdensome for both employees and contractors.

The new rules hold that if there are substantial “business reasons” for an employer to provide a cell phone to an employee (other than simply to provide the employee with the cell phone as a form of compensation), the value of any use of an employer-provided cell phone is excludable from the employee’s income. The IRS indicated that the business use of the cell phone will qualify as “a working condition fringe benefit,” and the personal use as “de minimis fringe benefit,” which means that employer-provided cell phone use now is deductible by the contractor and tax-free to the employee, without the burden of having to prove the business use, and without needing to separate personal use from business use.

The IRS gives examples of several acceptable business reasons to provide a cell phone to an employee:

  • The contractor’s need to contact the employee at all times for work-related emergencies;
  • The contractor’s requirement that the employee be available to speak with clients/customers at times when the employee is away; and
  • The employee’s need to speak with clients/customers located in other time zones at times outside of the normal workday.

The IRS also gives two examples that would not qualify as business reasons:

  • To promote the morale or good will of an employee; or
  • To attract a prospective employee or as a means of furnishing additional compensation to an employee.

The memo the IRS sent to examiners also addresses how the new rules will affect contractors who reimburse employees for using their personal cell phones for business. The IRS instructs examiners not to necessarily conclude that expense reimbursements for using a personal cell phone for business are income or wages as long as the contractor can show substantial business reasons (such as the above examples) for requiring employees to use personal cell phones in connection with the contractor’s trade or business. The IRS indicated that the employee must maintain coverage that is reasonably related to the contractor’s business needs, and the reimbursement cannot exceed the expenses the employee actually incurred.

Examiners also are told to more closely scrutinize arrangements where employees’ wages are reduced and replaced with a cell phone reimbursement (resulting in the replacement of taxable wages with a nontaxable benefit), or arrangements that allow for unusual or excessive expense reimbursements.

In conclusion, the new contractor-friendly rules discussed above provide those contractors that would like to have their employees available during non-working hours and/or available to talk with clients and customers, a great cost-saving way to do so.

Todd Taggart, CPA, CCIFP, is a Partner at Grant Thornton LLP. He coordinates construction taxation services for contractors and is Grant Thornton’s National Construction Practice Leader. He can be reached at 612-677-5193 or todd.taggart@us.gt.com.

Ben Spector, JD, is an Associate in the Compensation & Benefits Consulting group of Grant Thornton LLP. He can be reached at 612-677-5549 or ben.spector@us.gt.com.