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Annette Nellen
Cell Phones and Our Outdated Tax Law

Despite cell phones becoming inexpensive gadgets that even kids own, they remain suspect assets under the tax law. It's past time to modernize this 20th century rule.

August 17, 2009
by Annette Nellen, CPA/Esq.

This article was previously published in the AICPA Tax Insider.

In 1989, cellular telephones and similar telecommunications equipment became "listed property" under IRC §280F. This was just a few years after the FCC authorized the first commercial cell system in Chicago (Motorola (PDF), September 1984). In 1989, cell phones were too large for your pocket and too expensive for most people. The likelihood of such phones being purchased for business use and also personal use justified the 1989 tax law change.

But things have changed and the deduction limitations and documentation requirements no longer make sense. This article provides background on cell phone usage today, a brief overview about the cell phone tax rules, legislative proposals for change and recent simplification proposals from the IRS.

Ubiquitous

A study of cell phone usage in 2004 by The Pew Internet Project found (Internet and Cell Phone Facts):

Age group   Cell phone usage (%)
65+   46
50 - 64   75
30 - 49   82
18 - 29   80

In the U.S., about 26 percent of children age eight to 12 own a cell phone (Nielsen, September 2008). Almost 50 percent of married households with children own at least three mobile devices (Pew, New Connectedness, October 2008.).

IRC §280F

IRC §280F was enacted in 1984 to address concerns that advantageous depreciation rules and the investment tax credit were being used not only for capital formation but "to subsidize the element of personal consumption associated with the use of very expensive automobiles." (Joint Committee on Taxation, Tax Reform Act of 1984, JCS-41-84, January 1985.) The listed property limitation rules also applied to "other transportation equipment, entertainment, recreation or amusement property, computers or other property specified in regulations" (Conf. Rpt. to P.L. 98-369, July 1984).

Basically, if listed property is not used over 50 percent for business purposes, straight-line depreciation must be used. An employee who purchases or leases listed property may only claim deductions if the property is for the convenience of the employer and required as a condition of employment. In addition, §274(d) denies any deduction or credit for listed property "unless the taxpayer substantiates by adequate records or by sufficient evidence corroborating the taxpayer's own statement (A) the amount of such expense or other item, (B) the time and place of the ... use of the ... property" and "(C) the business purpose of the expense or other item."

These rules affect the usage of the property as an excludable working condition fringe benefit under §132 (Reg. §1.132-5(a)(1)(ii) and (c)(1)). Thus, detailed recordkeeping is crucial to enable a deduction and avoid extra income to the employee using the employer-provided property. The IRS recommends that "at a minimum, the employee should keep a record of each call and its business purpose" (IRS, Employee Cell Phones).

These rules are enforced. For example, in 2008, employment tax audits at two University of California campuses resulted in a combined assessment exceeding $400,000 due to improper compliance with the cell phone rules (UC memo (PDF) to the Committee on Compensation, May 2009). UCLA's new cell phone policy for employees, notes that "compliance with the IRS's current substantiation rules would be impractical."

Technological progress has not only made cell phones inexpensive and ubiquitous, but has also called into question the meaning of "similar telecommunications equipment" at §280AF(d)(4)(A)(v). For example, does that term include mobile devices for e-mail, Voice over Internet Protocol (VoIP) or Web-conferencing? Does such property fall within another outdated listed property category — "any computer or peripheral equipment?"

Modernization Options

While treatment of listed property may have made sense years ago when the cost of a cell phone exceeded $2,000 and the per-minute charges were about 50 cents, that isn't the situation today (Waring, "1988 vs. 2008: A Tech Retrospective," PC World, February 2008). Today, based on cost and usage, cell phones are more akin to a land line phone which for years an employee may have occasionally used to make a personal call without tax consequence.

Congress: Because the listed property designation is in the statute, Congress needs to take action to modernize these rules. While proposals have been introduced, nothing has been enacted. H.R. 5719 (110th Congress) which included a provision to remove cellular telephones from §280F passed in the House (April 2008), but not in the Senate. The Congressional Budget Office estimated that this change would cost $237 million over 10 years (CBO, H.R. 5719 Cost Estimate (PDF), April 2008).

Removal of cell phones from §280F was also included in H.R. 6601 (110th Congress), a small business simplification bill. S. 144 and H.R. 690 (111th Congress), "Modernize Our Bookkeeping in the Law for Employee's (MOBILE) Cell Phone Act," would remove cell phones from the definition of listed property. When introduced in the 110th Congress (S. 2668), sponsor Senator John Kerry (D-MA.) noted (Cong. Rec. S1203, February 2008):

"Cell phones are no longer viewed as an executive perk or a luxury item. They no longer resemble suitcases or are hardwired to the floor of an automobile. Cell phone and mobile communication devices are now part of daily business practices at all levels. … The current rule requires employers to maintain expensive and detailed logs and employers caught without cell phone logs could face tax penalties. …The tax code should keep pace with technological advances."

IRS: In June 2009, the IRS issued Notice 2009-46 proposing recordkeeping simplifications for cell phones. The IRS seeks comments on three alternatives and any other simplification ideas. The IRS proposals to simplify substantiation:

  1. Minimal Personal Use Method: An employer-provided cell phone will be deemed solely for business use if employees establish that they have and use a personal cell phone. A variation of this method would allow a minimal amount of personal use to be ignored.
  2. Safe Harbor Substantiation Method: Employers would be able to treat 75 percent of the costs as business use and the balance as personal use without the need to maintain records.
  3. Statistical Sampling Method: Employers could use "an approved statistical sampling methodology" to separate costs/use between business and personal.

The Internal Revenue Service (IRS) would likely require employers to have a written policy that prohibits employees from personal use of the phones. Employers would not be required to use a simplified method but could continue to use the current documentation rules.

The IRS seeks input on "whether a simplified valuation method" would be useful in determining the taxable value of personal use of an employer-provided cell phone.

Comments are also requested on other specified items including how to define "minimal" personal use. For example, should it be measured by minutes or a "list of acceptable personal uses." Comments are due by September 2009.

While the Notice seems to send a message that the IRS expects cell phones to remain as listed property, soon after its issuance, IRS Commissioner Douglas Shulman stated that the "passage of time, advances in technology and the nature of communication in the modern workplace have rendered this law obsolete." (Statement, June 2009).

Looking Forward

Congress will hopefully do the right thing and remove cellular phones from §280F so that the IRS can do more productive things than issue guidance on an out-of-date statutory provision.

The IRS call for comments on its simplification proposals places taxpayers and practitioners in an odd situation. Do we take time to write comments on how to improve a rule that should not even be in the tax law today or do we use the time to urge elected officials to update the law? Let's act wisely.

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Annette Nellen, CPA/Esq., is a tax professor and Director of the MST Program at San José State University. She is also a fellow with the New America Foundation. Nellen is an active member of the tax sections of the AICPA and ABA. She has several reports on federal and state tax reform and a blog.