8-3-07 Cell Phones and Their Impact on Taxable Income

Volume 20 For Publication Date: August 3, 2007 No. 17

Cell Phones and Their Impact on Taxable Income

The widespread popularity of school employers providing management and certain other employees with district-paid cell phones with which to conduct business can raise special tax concerns. Cell phones fall under the category of what the Internal Revenue Service (IRS) calls “Listed Property” (IRC Section 274). The IRS describes listed property as items that are “for use in a business but designated by the Internal Revenue Code as lending themselves easily to personal use.” Other examples of listed property include automobiles, computers, Internet provider allowances, and entertainment or recreation-related items.

In general, personal use of a cell phone or other listed property gives rise to a taxable benefit to the employee. The IRS has prescribed substantiation requirements for employers to support exclusion of an employer-owned cell phone from the taxable income.

First, all use is excludable from taxable income if the phone is used only for business purposes. Employers prove this to the IRS by:

1. Having a policy prohibiting personal use.

2. Performing routine audits of phone billings for personal calls.

In contrast, the employer must do the following when the phone is used for both business and personal use in order to exclude the use from taxable income:

1. Have a policy in place requiring employees to keep records.

2. Require the employee to keep a log of each call and its business purpose.

3. Require the employee to identify personal and business phone calls on the monthly statement from the cell phone company; and maintain support for all business calls.

Generally, if no policy exists or the employee does not keep, at a minimum, the records described above, the value of the phone use will be reported as income to the employee on
Form W-2.

Listed below are three examples from the IRS that illustrate the application of the rules:

· Example 1: A municipal government provides an employee a cell phone for business purposes. The agency’s written policy prohibits personal use of the phone. The agency routinely audits the employee’s phone billings to confirm that personal calls were not made. No personal calls were actually made by the employee. The business use of the phone is not taxable to the employee.

· Example 2. A municipal government provides an employee a cell phone for business purposes. The agency’s written policy prohibits personal use of the phone. However, the agency does not audit phone use to verify exclusive business use. The fair market value of the phone, each monthly service charge, and any individual call charges are taxable income to the employee, reportable on Form W-2.

· Example 3: A state agency provides an employee with a cell phone and pays the monthly service charge. The employee is required to highlight personal calls on the monthly bill. The employee is then required to timely reimburse the agency for the cost of the personal calls, and the employee is charged a pro rata share of the monthly charge. The value of the business-use portion of the phone is not taxable to the employee.

On the other hand, none of the listed property requirements are applicable if the employee owns the phone. Any amounts the employer reimburses to the employee for business use of the employee’s personal phone may be excludable from wages if the employee tracks the expense under the accountable plan rules. See Publication 15, Employer’s Tax Guide (Circular E), for more specific information about the rules.

We recommend districts consult their external auditors if there are any questions about their existing policies and procedures in this area.

The IRS article related to employee cell phones can be read in its entirety at http://www.irs.gov/govt/fslg/article/0,,id=167154,00.html.

— Lewis Wiley