Saturday, December 17, 2005

The IRS is now 0-10 on the telephone tax -- and people are starting to not pay it.

[Update: Class action lawsuit filed against the IRS!]

A third federal Court of Appeals has struck down the federal tax on long-distance telephone service (National Railroad Passenger Corporation (.pdf) , DC Circuit, No. 04-5421) bringing $9 billion in potential tax refunds for phone users that much closer to reality. The IRS now is zero-for-ten in these cases, with courts ordering more than $12 million of refunds in them, to big companies such as OfficeMax, Amtrak, and Honeywell International.

What's new now is that individuals are beginning to catch on and stop paying the tax. And phone companies are removing the tax from phone bills upon customer request.

The gist of the legal matter is that the Tax Code says telephone tax applies to long-distance calls that are billed individually by both time and distance. But few phone calls are billed that way today. And when calls are billed any other way -- by flat rate, time only, negotiated bulk rate, "friends and family", whatever -- heavy phone service users who are up on the law have begun asking for their tax money back. The IRS has responded by saying the "and" in "time and distance" actually means "or" -- but the courts haven't bought that yet, and have been giving back the tax.

Nevertheless, the IRS is refusing to pay refunds and recently issued a formal notice (.pdf) saying all phone users are required to still pay the tax.

Which raises a problem: What to do if you don't want to pay a tax that the courts say you don't owe, but your phone tax bill isn't big enough, and your pockets aren't deep enough, to fight the IRS through the courts for a million dollar refund?

If you have a small business paying significant but not huge phone taxes the thing to do is to file a "protective refund claim" for taxes paid three years back. The IRS won't pay it now, but this will keep your potential refunds from expiring due to the three year statute of limitations that applies to refund claims. Then you wait as the big boys fight it out. If the IRS gives up in the end you'll get your money, without a court fight. Your business's tax advisor can file the protective refund claim for it.

If you are an individual whose monthly phone tax bill is so small that it doesn't pay even to go through the paperwork of a formal refund claim, but you still don't want to pay a tax you don't owe, there's a simpler option -- just stop paying the tax.

The phone companies are required by the IRS to collect the tax but not to enforce it. The first mainstream media story I've seen on this subject in the two years it has been developing reports that AT&T, Cingular Wireless, MCI, and Verizon Wireless now remove the tax charge from phone bills when asked to do so by customers. If they do I imagine their competitors do as well.

(The phone companies hate this tax, which was imposed as a temporary "luxury tax" in 1898 to help finance the Spanish-American war -- thus showing what Congress means by "temporary tax". The heads of all the big phone companies recently sent a letter (.pdf) to Treasury Secretary Snow urging him to instruct the IRS to give up on this, stop collecting the tax, and give everyone their money back. They want to get rid of this tax and aren't going to go out their way to give a hard time to growing numbers of customers who join them in this.)

What happens if an individual just stops paying the tax, having the phone company take the tax off the phone bill?

Well, probably nothing, at least for some while. The phone company informs the IRS of the fact, giving the customer's name and the amount of tax not collected. But then the small amount of money at issue per individual works against the IRS -- it can't afford to spend resources attempting to collect such small amounts, especially while all the courts are ruling the tax illegal. (The news story linked to above mentions individuals who haven't paid the tax for years, as anti-government protestors, and have never heard from the IRS.)

In the longer term, nobody can say for sure. If the tax somehow is reinstated as it was, non-payers might get back tax bills. But as they could show their failure to pay was based on a reasonable interpretation of the law backed by three Court of Appeals decisions, and contradicted by none, they should escape any penalties. That would leave them just paying the (modest for them) amount of tax itself plus interest -- basically same fiscal place as if they'd paid the tax to begin with.

(More background plus legal and case citations available here.)