United States: Government Concedes Defeat on Telephone Excise Tax

On May 25, 2006, the Internal Revenue Service ("IRS") announced that it would stop collecting the federal excise tax on long-distance telephone service charges that are purely time based. Notice 2006-50 reverses the once defiant position of the IRS and states that taxpayers will no longer be required to pay a tax on charges for long-distance telephone service that are based solely on the amount of time for the phone call. Long distance providers may not bill or collect the excise tax on such service after July 31, 2006. Additionally, taxpayers will be able to seek a refund of taxes paid during the period after February 28, 2003 and before August 1, 2006.

The new position taken by the IRS reverses its previous interpretation of section 4252(b)(1) of the Internal Revenue Code ("Code"). Although section 4252(b)(1) imposes an excise tax on charges for long-distance telephone service for which the charges are measured by both time and distance of the call, the IRS had previously taken the position that the tax also applied to charges that only varied by time. Numerous court decisions, including cases in the Second, Third, Sixth, Eleventh, and D.C. Circuit Court of Appeals, rejected that position and held that the plain language of 4252(b)(1) only allowed a tax on those long-distance charges that were based on both time and distance of the call. Despite the mounting disagreement from the courts, the IRS had previously continued to assert its contrary position.

With the recent acquiescence by the IRS, taxpayers are now eligible to file for refunds of all excise tax they have paid on time based long-distance service billed to them after Feb. 28, 2003. Interest will be paid on such refunds.

Taxpayers may request a credit or refund from the IRS of taxes paid on time based long-distance services from February 28, 2003 to August 1, 2006 only on their 2006 Federal income tax returns. Entity taxpayers, including corporations, partnerships, estates and trusts and tax exempt organizations may request only the actual amount of tax paid on such services billed during the relevant period. Individual taxpayers may request either the actual amount of tax paid or a safe harbor amount not yet determined by the IRS. Forms 1040 (series), 1041, 1065, 1120 (series), and 990-T for 2006 will include a line for requesting the overpayment amount. Entities that are not otherwise required to file a federal income tax return must file Form 990-T to request the credit or refund.

The instructions for the respective federal income tax return forms will provide additional guidance. The forms and instructions will require taxpayers to certify that (1) the taxpayer has not received from the long-distance service provider ("telephone company") a credit or refund of the tax claimed on the return and (2) the taxpayer will not ask the telephone company for a credit or refund of the tax and has withdrawn any such request previously submitted.

Taxpayers will also be required to retain records that substantiate the request. Those records should include bills from the collector of the tax, usually the telephone company, that show the amount of tax charged for nontaxable service for each month during the relevant period and receipts, canceled checks, or other evidence that the amount requested was actually paid.

Currently, the IRS states that it will not accept requests for a credit or refund on any other form, such as Form 720, 843, or 8849.

In lieu of seeking the tax refund from the IRS, taxpayers may seek the funds directly from the telephone company. However, while telephone companies may repay the tax collected on charges billed before August 1, 2006, they are not required to do so.2 If a telephone company voluntarily pays refunds to its customers, it may request a credit or refund of the taxes previously collected and paid to the IRS. In that case it must either establish that it has repaid the amount of the tax to the person from whom the tax was collected, or obtain the written consent of such person to the allowance of the credit or refund. Generally, telephone companies may use Form 720X Amended Quarterly Federal Excise Tax Return, line 1, IRS No. 22, for credit or refund of amounts collected and repaid to taxpayers.

1. The current excise tax rate is 3% of the charges billed for these services.
2. Conversely, collectors must repay to taxpayers any tax collected on services billed after July 31, 2006.

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