Will Congress Relax the Cell Phone Rules?

Legislation would make claiming cell phone usage as a business expense much easier.

Church Finance Today

Will Congress Relax the Cell Phone Rules?

Legislation would make claiming cell phone usage as a business expense much easier.

Background. Many churches provide cell phones to some employees. This can raise special tax concerns, due to the fact that cell phones are designated as “listed property” by section 280F of the tax code.

Listed property includes various items that are acquired for business use but that lend themselves to personal use as well. This includes automobiles, computers, and entertainment or recreation-related items. The tax code imposes stricter substantiation rules on these kinds of property to ensure that any personal use is identified and reported as taxable income.

In 1989, cell phones were added to this category because the cost of acquiring and using them was so steep that Congress was concerned that taxpayers would claim inflated business expense deductions and reimbursements without reporting the inevitable personal use as taxable income. Over the years, as the cost of acquiring and using cell phones declined, the rationale for treating them as listed property diminished. But, they remain on the list and are subject to the limitations that apply to listed property.

Substantiation requirements. What special substantiation rules apply to items of listed property, including cell phones? Consider the following:

1. What must be substantiated?

Section 1.274-5T of the income tax regulations specifies that no deduction shall be allowed for the use of listed property unless the taxpayer substantiates the following:

(i) Amount. The amount of each separate expenditure for an item of listed property, such as the purchase cost, and “the amount of each business use … based on the appropriate measure (i.e., time for listed property) … and the total use of the listed property for the taxable period.”

(ii) Time. The date of the expenditure or use with respect to an item of listed property.

(iii) Business purpose. The business purpose of each expense or use associated with any listed property. This means that the business purpose of every cell phone call must be established with adequate records.

2. What is substantiation?

Section 274 of the tax code states that no business expense deduction is allowed for any item of listed property “unless the taxpayer substantiates by adequate records or by sufficient evidence corroborating the taxpayer’s own statement” the elements of amount, time, and business purpose summarized above. An adequate record is defined by the tax regulations as follows:

An account book, diary, log, statement of expense, trip sheets, or similar record … and documentary evidence … which, in combination, are sufficient to establish each element of an expenditure or use …. An account book, diary, log, statement of expense, trip sheet, or similar record must be prepared or maintained in such manner that each recording of an element of an expenditure or use is made at or near the time of the expenditure or use …. In order to constitute an adequate record … which substantiates business use of listed property the record must contain sufficient information as to each element of every business use. (emphasis added)

Tip. You may maintain an adequate record for parts of a year and use that record to substantiate the amount of business expense for the entire year if you can demonstrate by other evidence that the periods for which an adequate record is kept are representative of your expenses throughout the entire year. The income tax regulations specify that “a taxpayer may maintain an adequate record for portions of a taxable year and use that record to substantiate the business use of listed property [such as a cell phone] for all or a portion of the taxable year if the taxpayer can demonstrate by other evidence that the periods for which an adequate record is maintained are representative of the use for the taxable year or a portion thereof.” Treas. Reg. 1.274 5T(c)(3)(ii)(A).

Key point. The substantiation requirements for cell phones apply both to church employees who are claiming a deduction for the business use of a cell phone on their tax return and to reimbursements of business expenses under a church’s accountable reimbursement policy. The requirements are the same in both contexts.

3. Additional requirements for depreciation

The tax code specifies that employees may not claim a depreciation deduction for an item of listed property “unless such use is for the convenience of the employer and required as a condition of employment.”

For a cell phone to satisfy the “convenience of the employer” requirement, it must meet two requirements: (1) It must be required in order for the employee to properly perform his or her job; and (2) it must be provided for a substantial noncompensatory business reason, such as the immediate accessibility of the employee in the event of an emergency, or the inadequacy of the employee’s office telephone.

A cell phone is required as a condition of employment if an employee cannot properly perform his or her duties without the phone. It is not necessary that the church explicitly requires an employee to use a cell phone.

IRS summary. The IRS summarizes the substantiation requirements as follows:

To be able to exclude the use by an employee from taxable income from an employer-owned cell phone, the employer must have some method to require the employee to keep records that distinguish business from personal phone charges. If the telephone is used exclusively for business, all use is excludable from income (as a working condition fringe benefit). The amount that represents personal use is included in the wages of the employee. This includes individual personal calls, as well as a pro rata share of monthly service charges.

In general, this means that unless the employer has a policy requiring employees to keep records, or the employee does not keep records, the full value of the use of the phone will be income to the employee.

At a minimum, the employee should keep a record of each call and its business purpose. If calls are itemized on a monthly statement, they should be identifiable as personal or business, and the employee should retain any supporting evidence of the business calls. This information should be submitted to the employer, who must maintain these records to support the exclusion of the phone use from the employee’s wages.

Examples. The following situations illustrate the application of the rules:

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

Example. A church 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 church 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.

Caution. A church should not reimburse employees’ expenses under an accountable reimbursement arrangement that do not qualify as business expenses. Such reimbursements, as well as a church’s reimbursement of employees’ unsubstantiated business expenses, are nonaccountable. If these reimbursements are not reported as taxable income to the employee in the year the reimbursements are paid, there are two consequences: (1) The employee is subject to back taxes plus penalties and interest on the unreported income. (2) If the benefits are provided to an officer or director of the church (a “disqualified person”), or a relative of such a person, they will expose the recipient and possibly other members of the church’s governing board to “intermediate sanctions” in the form of substantial excise taxes since the IRS now views these benefits as “automatic” excess benefits unless reported as taxable income by the church or recipient in the year provided.

Key point. The IRS has issued audit guidelines for its agents to follow when auditing corporate executives. The guidelines are instructive in evaluating the compensation packages provided to senior pastors and other church employees. The guidelines specify: “Special record-keeping rules apply to computers except for those used exclusively at the business establishment and owned or leased by the person operating the business. Detailed records are required to establish business use of computers that can be taken home or are kept at home by the executives. There are no record keeping exceptions like ‘no personal use’ available for computers. Similar recordkeeping problems arise for cellular and car phones. This requires documentation of business usage in order for the purchase and operational cost to be an allowable deduction and not included as income to the executive.”

If the employee owns the cell phone, the listed property requirements do not apply. Any amounts the employer reimburses the employee for business use of the employee’s own phone may be excludable from wages if the employee accounts for the expense under the accountable plan rules.

The need to relax the substantiation rules for cell phones. For most taxpayers and employers, the burden of complying with the substantiation requirements for the business use of cell phones is not justified by the marginal tax savings that would result. Yet, the Tax Court and IRS have both refused to relax the substantiation requirements on the ground that Congress created these requirements and only it can change them.

The Modernize Our Bookkeeping In the Law for Employee’s Cell Phone Act of 2008. In February, Congressman Sam Johnson of Texas introduced the Modernize Our Bookeeping in the Law for Employee’s Cell Phone Act of 2008. In introducing his bill, Johnson noted:

Picture a cell phone in 1989. Back then, cell phones were huge, the size of a suitcase, and air time cost a fortune. A law was put in place in 1989 to require that detailed log sheets be kept by employees of their cell phone use in order to document their business use. Those rules made sense back then. Fast forward to today. Clearly, time and technology have marched on and companies give their employees cell phones and Blackberrys with unlimited minutes. And these communication devices are really just an extension of the business day and place to anywhere at any time.

The IRS wants employees to keep detailed call sheets or be forced to include the value of cell phones and Blackberrys in their pay. The law needs to be brought up to date with the fact that the office cell and Blackberry is just an extension of the phone on an employee’s desk. Employees and employers have better things to worry about than keeping detailed logs of calls only for tax purposes. It’s time for the Congress to pass the Mobile Cell Phone Act … and stop the IRS harassment.

Johnson’s solution is simple. His bill would remove cell phones (and similar telecommunications devices) from the list of listed property under section 280F of the tax code, beginning after December 31, 2007. This legislation (H.R. 5450) has been referred to the House Ways and Means Committee. At the time of publication, there were 12 cosponsors.

The removal of cell phones from the list of listed property would make it much easier for church employees to account to their employing church for the business use of a church-provided cell phone, or to claim a business expense deduction on their tax return for cell phone expenses that are either unreimbursed or reimbursed under a nonaccountable arrangement. In general, the business use of a cell phone could be proven using the so-called Cohan rule. Under this rule, which gets it name from a 1930 court case, if the evidence indicates that a taxpayer incurred deductible business expenses but the exact amount cannot be determined, a court is permitted to make a “close approximation” of the expenses and not disallow the deduction entirely.

Key point. The substantiation requirements must be met not only by employees wanting to claim a tax deduction for the business use of their phone that is not reimbursed by the church, but also by the church in reimbursing expenses under an accountable arrangement. The requirements are identical.

This article first appeared in Church Finance Today, May 2008.

Richard R. Hammar is an attorney, CPA and author specializing in legal and tax issues for churches and clergy.

This content is designed to provide accurate and authoritative information in regard to the subject matter covered. It is sold with the understanding that the publisher is not engaged in rendering legal, accounting, or other professional service. If legal advice or other expert assistance is required, the services of a competent professional person should be sought. "From a Declaration of Principles jointly adopted by a Committee of the American Bar Association and a Committee of Publishers and Associations." Due to the nature of the U.S. legal system, laws and regulations constantly change. The editors encourage readers to carefully search the site for all content related to the topic of interest and consult qualified local counsel to verify the status of specific statutes, laws, regulations, and precedential court holdings.

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