As part of the Small Business Jobs Act of 2010, signed into law by President Obama on September 27, 2010, cellular telephones and other similar telecommunications equipment are no longer classified as “listed property” for deduction and depreciation purposes, effective for tax years beginning after December 31, 2009. In recent years, Congress has been under increasing pressure to remove cell phones from inclusion as listed property due to the onerous recordkeeping requirements involved and the widespread use of employer provided cell phones.
Prior to the new law being passed, The IRS treated cell phones as “listed property,” meaning that detailed records had to be kept segregating business and personal cell phone use in order to claim a tax deduction for the business use portion. Failing to maintain adequate documentation resulted in lost deductions and possible federal employment tax assessments for employers, not to mention potential automatic excess benefit taxes incurred by employees of nonprofits who had failed to properly account for personal use.
When cell phones were treated as listed property, and business use was 50% or below in the first year that the phone was placed in service, depreciation had to be taken on a straight-line basis, with the phone assigned a useful life of ten years in accordance with MACRS alternative depreciation system (ADS). Also, no bonus depreciation or Internal Revenue Code (IRC) Section 179 expensing was permitted. If a cell phone was used for business purposes greater than 50% in the first year of service, but business use fell to below 50% in a subsequent year, any bonus depreciation or IRC Section 179 deduction previously taken had to be recaptured in the year that business use declined below 50%.
Under the new rules, cell phones used less than 50% for business in the year placed in service may be depreciated using a 7-year useful life and a 200% declining balance method under the MACRS General Depreciation System (GDS). Since cell phones are no longer classified as listed property, bonus depreciation may be claimed in 2010 even if used less than 50% for business. If business use is greater than 50% in the year placed in service but falls below 50% in subsequent years, bonus depreciation no longer has to be recaptured.
The rules regarding IRC Section 179 deductions, however, apply to listed and nonlisted property alike. Therefore, under the new law, cell phones still must be used for business purposes greater than 50% in the year placed in service in order to take an IRC Section 179 deduction. Also, if business use is greater than 50% in the year placed in service but falls below 50% in subsequent years, any IRC Section 179 deduction must be recaptured.
Treatment as a Fringe Benefit
In its report on the new law, the Joint Committee on Taxation mentions that the new law does not clarify (or provide guidance) as to whether employer-provided cell phones should be treated as a working condition fringe benefit under IRC Section 132(d), or if an employee’s personal use of an employer-provided cell phone should be treated as a de minimis fringe benefit under IRC Section 132(e).
Subsequent guidance from the IRS is expected on the treatment of an employer provided cell phone for purposes of IRC Section 132.
Amount of Employee Income from Personal Use of Employer-Provided Cell Phone
An employee who receives a fringe benefit must include in gross income the amount by which the fair market value of the fringe benefit exceeds the sum of: (a) the amount, if any, that the employee paid for the benefit, and (b) the amount, if any, specifically excluded from gross income by some other section of the Internal Revenue Code.
Thus, until further guidance is provided by the IRS with respect to employer-provided cell phones, the fair market value of an employee’s personal use of the cell phone (reduced by the employee’s reimbursement, if any) should be included in the employee’s gross income.
Under the new law, the elimination of “listed property” treatment for cell phones makes it easier to claim employer-provided cell phones as excludable working condition fringe benefits because onerous substantiation requirements no longer apply to cell phones. However, even personal use of a working condition fringe benefit property or service must be included in an employee’s gross income. Thus, absent a specific exclusion for personal cell phone use as a de minimis fringe benefit, an employee must include any personal use in the employee’s gross income.
In June 2009, the IRS issued Notice 2009-46, 2009-23 IRB 1068, which set forth proposed simplified procedures by which employers could substantiate an employee’s business use of employer-provided cell phones. The IRS was considering three alternative methods: (1) a minimal personal use method; (2) a safe harbor substantiation method; and (3) a statistical sampling method.
With respect to the minimal personal use method, two proposals would have allowed an employer to deem all of the employee’s use of an employer-provided cell phone as business usage (i.e., nonpersonal use). Under the first proposal, the entire amount of an employee’s use of an employer-provided cell phone would have been considered to be for business purposes if the employee could account to the employer, with sufficient records, that the employee maintained and used a personal cell phone for personal purposes during the employee’s work hours. Alternatively, the second proposal defined a specified amount or type of “minimal” personal use that would have been disregarded in determining usage. This second proposal would presumably qualify as a de minimis fringe benefit.
Under the safe harbor method, an employer would treat a specified percentage (proposed by the IRS to be 75%) of each employee’s use of an employer-provided cell phone as business usage, and treat the balance as personal use.
The IRS was also considering a proposal that would have allowed employers to use statistical sampling techniques to measure an employee’s personal use of an employer-provided cell phone. The employer would have multiplied that percentage by an employee’s total usage to determine the value of personal usage. The remaining portion would be considered to have been used for business purposes.
In Notice 2009-46, the IRS requested comments from taxpayers on proposed methods as well as on alternative methods. To date, the IRS has not issued any follow-up guidance to the announcement. Thus, there has been no determination of what would constitute “minimal use” to deem an employee as having no personal use of the employer-provided cell phone.
Until further guidance is issued by the IRS regarding the treatment of personal use of an employer-provided cell phone, we would recommend that employers develop a consistent approach to determining an employee’s personal use of a cell phone. For now, the fair market value of such personal use should either be included in an employee’s gross income or charged to (and collected from) the employee on a regular periodic basis.
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This advice is not intended or written to be used for, and it cannot be used for, the purpose of avoiding any federal tax penalties that may be imposed, or for promoting, marketing or recommending to another person, any tax-related matter.