GT Alert

Taxpayers May Be Entitled To Refunds of Federal Excise Taxes Paid On Long Distance Telephone Service

May 2005

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For more than a century, users of telephone service have been subject to a Federal Excise Tax on telephone service. Originally enacted in 1898 as a temporary measure to finance the Spanish-American War, the excise tax on telephone service has never been repealed (although it almost was eliminated in 2000). The current tax rate is three percent and is applicable to “local telephone service,” “toll telephone service,” and “teletypewriter exchange service.” However, a series of recent court cases, including a May 10, 2005 ruling by the United States Court of Appeals for the Eleventh Circuit, has left in doubt whether the Federal Excise Tax remains applicable to “ toll telephone service” (commonly referred to as long distance service). Because of changes in how long distance service is provided since the time that the current law was written, the statutory definition of “toll telephone service” no longer fits with the manner in which such service is provided. Thus, clients may be entitled to refunds of Federal Excise Tax amounts paid on toll telephone service.

“Toll Telephone Service” Under the Internal Revenue Code

Section 4252(b) of the Internal Revenue Code defines “toll telephone service” as:

(1) a telephonic quality communication for which (A) there is a toll charge which varies in amount with the distance and elapsed transmission time of each individual communication and (B) the charge is paid within the United States, and

(2) a service which entitles the subscriber, upon payment of a periodic charge (determined as a flat amount or upon the basis of total elapsed transmission time), to the privilege of an unlimited number of telephonic communications to or from all or a substantial portion of the persons having telephone or radio telephone stations in a specified area which is outside the local telephone system area in which the station provided with this service is located.

The problematic part of the “toll telephone service” definition is the reference to “distance” in subsection (1). The statutory definition of “toll telephone service” was enacted in 1965. At that time, telecommunications markets, including the long distance market, had not yet been opened to competition, and all toll service was provided by the American Telephone & Telegraph Company (AT&T), jointly with the nation’s local telephone companies (including the Bell companies which AT&T owned, and the so-called “independent” companies). AT&T’s pricing structure for toll service included charges which varied depending on the duration of the call and with the distance which the call traveled (e.g., a five minute call between New York and Los Angeles was more expensive than a five minute call between New York and Washington, D.C.).

Despite the fact that the telecommunications industry is radically different than it was in 1965, the definition of toll telephone service was never amended to reflect those changes. Over the past decade, the long distance industry has moved away from distance sensitive pricing. Today, providers of toll service utilize “postalized” rate structures – the per minute price of an interstate call is the same to all out-of-state locations (for example, “call anywhere for $0.05 per minute!”). Although intrastate rates often differ from interstate rates, they too do not vary based on distance. With the exception of calls to Mexico (where there are still rate bands based on distance), all international calls between the U.S. and foreign points are subject to postalized rates which do not vary with distance on either the U.S. or foreign end.

Taxpayer Challenges to the Excise Tax on Telephone Toll Service

Several years ago, taxpayers began to question whether the Federal Excise Tax was applicable to toll services where the rates did not vary with distance. Refund claims were filed with the IRS, none of which were granted. Following those denials, civil lawsuits against the government were filed in various federal courts. With one exception, every court which considered the question concluded that the Federal Excise Tax was not applicable to toll service where the rates did not vary with distance. The one exception was the U.S. District Court for the Southern District of Florida in a case brought by American Bankers Insurance Group, Inc. That court accepted the Government’s argument that the word “and” (“varies in amount with the distance and elapsed transmission time”) was ambiguous and concluded that the word “and” should be given a disjunctive meaning rather than a conjunctive meaning (effectively converting the word “and” to “and/or”). The court ruled against American Bankers Insurance Group which appealed the ruling to the Eleventh Circuit.

In its May 10 opinion in American Bankers Insurance Group, Inc. v. United States (Case No. 04-10720), the Court of Appeals reversed the District Court and stated that the statutory language is subject to the plain meaning rule. Quoting from a recent Supreme Court case, the appeals court stated that, in construing a statute, “[t]he preeminent canon of statutory interpretation requires us to presume that the legislature says in a statute what it means and means in a statute what it says.” In other words, “and” means “and.” “And” does not mean “and/or.”

In finding the language of Internal Revenue Code Section 4252(b) to be unambiguous, the Eleventh Circuit reached the same conclusion as did four U.S. District Courts and the Court of Federal Claims (twice) in cases involving the telephone excise tax’s applicability to telephone toll service where the rates do not depend on distance. Significantly, the Eleventh Circuit opinion is the first court of appeals ruling which has addressed the question.

As recently as August 2004, the IRS announced that it would continue to assess and collect the telephone excise tax on toll telephone service, notwithstanding the litigation challenging the law. At that time, the IRS took comfort in the fact that even though most of the courts which had considered the issue had concluded that the tax is not applicable to non-distance-based toll service, one court did agree with the IRS. Now that one court has been reversed.

What Happens Now

It is possible that Congress could enact corrective legislation removing the reference to distance in the toll service definition. However, such legislation seems unlikely. In 2000, Congress passed a bill which would have eliminated the Federal Excise Tax on telephone service as part of a larger budget bill. However, that bill was vetoed by President Clinton for unrelated reasons. Earlier this month, Rep. Gary Miller (R-CA) introduced in Congress a bill which would repeal the excise tax. Whether or not that bill passes, legislative sentiment seems to favor abolishing the 107 year old tax, not fixing it. It is possible that other federal circuit courts of appeal might reach contrary conclusions to that of the Eleventh Circuit. It is also possible (although highly unlikely) that the government will ask the Supreme Court to review the Eleventh Circuit ruling and that the Supreme Court will agree to hear the case.

Telephone Excise Taxpayers Should Consider Seeking Refunds

Consumers of long distance telephone service should consider filing claims with the IRS seeking refund of taxes paid on toll telephone service. At this point, it is not known whether the IRS will change its refund policy in light of the recent court of appeals decision, but even if the IRS chooses to “stick to its guns” and continues to deny refund claims, seeking refund and being denied is a necessary condition precedent to going to court to challenge the IRS denial.

The right to refund is not unlimited. There is a three year statute of limitations on refund claims with the IRS. Thus, taxpayers may not claim refunds for Federal Excise Tax paid before May 2002 (assuming that refund claims are filed immediately). Also, IRS refund procedures require that claims be thoroughly documented. Records of payments – preferably photocopies of invoices – must be attached to any refund claims. For companies who have not saved their telephone bill records for the past three years, it is possible that your vendors will be able to provide copies of bills to you.

This firm would be pleased to assist clients in preparing and filing refund claims with the IRS and initiating legal actions in appropriate courts to recover previously-paid excise taxes on toll telephone services.

This Alert was written by Mitchell Brecher in the Washington, DC office. Please contact Mr. Brecher at 202.331.3152 or your Greenberg Traurig liaison if you have any questions regarding the subject matter of this Alert.

© 2005 Greenberg Traurig

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