Cell phones, per diems, and tax exclusions
By Edwin Zalewski, PHR, SHRM-CP
According to the Internal Revenue Service (IRS), all compensation given to employees (whether cash, goods, or property) is taxable unless a specific exclusion applies. For example, the portion of health insurance premiums paid by the employer does not count as taxable income. The IRS allows a number of other exclusions, but employers need to be aware of the limitations for using them.
This article looks at cell phones and per diems.
If an employer provides a cell phone for business use, any personal use does not have to be counted as taxable income — even if company policy prohibits personal use, but the employee violates that policy and incurs charges (e.g., from data downloads). Of course, the employer may require the employee to repay the company for those charges.
Conversely, if an employer provides a cell phone as a benefit (specifically intended for personal use), the value is taxable income. Even though the compensation is not in cash, the value must be reported on the employee’s W-2.
Some employers provide an allowance for business use of a personal cell phone, such as paying $20 per month. These payments may be excluded from taxable income only if the employer follows the accountable plan rules. The accountable plan rules have three requirements:
- There must be a business connection to the expense,
- The employee must account for the funds within a reasonable time, and
- Any excess allowance must be returned to the employer.
Giving an allowance without substantiating the business use would be taxable income. In simple terms, the employee must verify the date, time, and business purpose of expense. The employee must also provide receipts and, if the allowance was more than the actual costs, return any excess. Otherwise, the entire allowance is taxable and must be reported on the employee’s W-2.
Employers may choose to report an allowance as income even if it could have been excluded, then advise the employee to keep records of business use. The employee could then claim a personal tax deduction for any business use.
Some employers reimburse employees for travel costs by requesting receipts for actual expenses. Other employers use per diems. A per diem is a fixed daily allowance for lodging, meals, and incidental expenses (M&IE). The IRS has specific requirements for excluding per diems from taxable income.
Rates are established for geographic areas and are revised annually. Employers may pay established per diems without counting the payment as taxable income, even without obtaining receipts. However, employees must document the date, time, place, and business purpose for the trip. Also, the travel must involve an overnight stay. Reimbursement for meals on a one-day trip would be taxable income, although mileage reimbursement for business use of a personal vehicle may be a tax-free even if the travel does not require an overnight stay.
In addition, employees may not qualify for a full per diem on the first or last day of travel. For example, an employee returning from an overnight trip might arrive home mid-afternoon and have dinner at home. The employee should not receive reimbursement for that meal. Employers must therefore prorate the M&IE amount for the first and last day of travel. Employers may either:
- Pay three-quarters of the per diem, or
- Calculate a percentage of the per diem based on hours worked and traveled on the first and last days (or use a similar method to determine a reasonable percentage of the per diem).
Note that per diems do not include personal vehicle mileage, nor expenses such as cab fare, so employers using per diems may reimburse costs beyond the per diem amount.
Whichever methods you adopt for reimbursing business expenses, be sure you understand the substantiation requirements to avoid providing employees with untaxed income.