Payroll in Practice: 4.8.20

Practitioners’ questions are answered by a payroll and tax consultant who also is an enrolled agent licensed to practice before the Internal Revenue Service.

Question: Some of our employees are to receive an allowance toward the business use of their personal mobile phones. Does this make the allowance taxable to the employees?

Answer: The allowances may be excluded from employee wages as a working-condition fringe benefit, provided certain requirements are met. The allowances must be granted to employees for noncompensatory business reasons and the amount must be reasonable.

This is related to the treatment of employer-provided mobile phones. The underlying requirements for exclusions from wages are essentially the same. Internal Revenue Service Notice 2011-72 provides that when an employer provides an employee with a mobile phone for noncompensatory business reasons, the employee’s business-related usage is treated as a working condition fringe benefit and is excluded from gross income.

When determining whether the working condition fringe benefit exclusion applies, the substantiation requirements for the exclusion are deemed to be satisfied. Thus, a log of business and personal use of the phone is not required, but the business purpose for providing the phone should be documented.

Additionally, the value of any personal use of a phone that meets the above requirements will be treated as excludible from the employee’s gross income as a de minimis fringe benefit.

The notice included examples of substantial noncompensatory business reasons, such as the employer’s need to contact the employee for work-related emergencies, the employer’s requirement that the employee be available to speak with clients when away from the office, and the employee’s need to speak with clients at times that occur outside at the employee’s normal work day.

However, a mobile phone provided to boost employee morale or promote goodwill, to recruit a potential employee, or as a means of providing added compensation is not considered as primarily for noncompensatory business purposes.

While Notice 2011-72 applies only to employer-provided mobile phones, the IRS, within a few days of issuing the notice, sent audit guidance to its field agents that extended the exclusion to reimbursement for business use of a personal mobile phone.

The rules are similar to an employer-provided phone. When the allowance is provided for non-compensatory business purposes and the amount or the allowance is reasonable, the allowance amount will be treated as reimbursement for the cost of a working condition fringe benefit and can be excluded from employee income, presumably as a reimbursed employee business expense under an accountable plan. See the IRS memorandum for all field examination operations dated Sept. 14, 2011 at https://www.irs.gov/pub/foia/ig/sbse/sbse-04-0911-083.pdf.

This is important because under the tax code overhaul, which took effect Jan. 1, 2018, unreimbursed employee business expenses, previously allowed as miscellaneous itemized deductions subject to the two percent of adjusted gross income floor, are currently not deductible. If an employee receives an allowance for use of the phone that is treated as taxable income, the employee takes a double tax hit. First, the allowance is additional taxable income, and second the employee cannot deduct the expense.

Under an accountable plan, an employer must have documentation that the phone is used or is required to be available for a bona fide business purpose of the employer and the reasonable cost of that availability must be established.

The reasonable-cost element does not provide for a clear allowable value. However, the notice discusses the cost of maintaining a mobile phone. Some commentating on the issue indicate this may be considered the entire basic cost of the phone, excluding features that are not required for business use. Others think a proportionate amount based on some documented average relative business use may be appropriate.

Apart from federal law, California employers are required to reimburse employees for the reasonable cost of business use for a personal mobile phone under a 2014 California appeals court ruling (Cochran v. Schwan’s Home Services Inc.).

Question: We transitioned to new payroll software program this year. An employee has a carryover W-4 that claimed a negative amount of additional withholding, presumably to avoid receiving a large refund. The new software will not accept a negative amount for additional withholding, whether from the existing W-4 or from the 2020 W-4. How can we handle this?

Answer: The instructions for prior-year Forms W-4, Employee’s Withholding Allowance Certificate, and the redesigned 2020 Form W-4, Employee’s Withholding Certificate, indicate that additional withholding is an additional amount. In contrast, the Connecticut Form CT-W4, Employee’s Withholding Certificate, has a line to indicate the tax table to be used, a line for an increase in withholding over the table amount, and a line for a reduction in the amount specified in the table.

My interpretation is that the federal W-4 allows for additional withholding but not for a negative amount of additional withholding. Allowing that would allow an employee to specify no allowances and a large amount of negative withholding to offset the withholding resulting from zero allowances. This essentially sets a flat amount of withholding per pay period regardless of any fluctuations in compensation.

The new 2020 W-4 makes adjusting withholding to a specific amount easier while maintaining flexibility with regard to fluctuations in wages. For example, the amount on Line 4(b) for deductions could be increased, which would result in a decrease in withholding from the amount otherwise specified in the tax tables. This is likely a bit easier than computing an increase in the number of allowances that would be required to get the amount of desired withholding as would be the case for W-4 Forms from years before 2020.

The employee may want to try out the IRS withholding tax estimator on the IRS website. However, some work is involved to collect and enter all the relevant information.

When the desired amount of withholding per period is known, the employee might use the IRS withholding tax calculator for employers to determine how much to enter into Box 4(b) to achieve the desired results. This could be achieved by entering the pay period, period salary, and marital status in the calculator, selecting the 2020 and later W-4 option, then entering numbers into Box 4(b) until the desired withholding is achieved.

The employee would then provide a 2020 Form W-4 with Step 1 (name, address, and marital status), Step 4(b) (Deductions), and Step 5 (Signature and date) completed.

By Patrick Haggerty

Do you have a question for Payroll in Practice? Send it to phaggerty@prodigy.net.