IRS Publishes Advance NPRM Regarding Expanding the Excise Tax on Telephones to Include New Technologies

July 2, 2004. The Internal Revenue Service (IRS) published a notice in the Federal Register which it identifies as an "advance notice of proposed rulemaking". This notice states that the IRS seeks comments on expanding the current three percent excise tax on telephone service to new "communications services" to "reflect changes in technology".

The vaguely worded and short notice does not put readers on notice of whether or not the IRS plans to promulgate a rule that expands the tax to include any or all voice over internet protocol (VOIP) services, applications, or technologies, or any other IP based communications.

The IRS notice asserts that "Since 1965, numerous communications services have been developed and marketed, the methods of transmission have expanded, and the industry has been deregulated. As a result of these changes, questions have arisen concerning the application of section 4251 to certain communications services that were not available in 1965. In response to these questions, Treasury and the IRS are considering proposing regulations that would revise the existing regulations to reflect changes in technology."

The IRS's notice adds that the purpose of the notice is "to solicit information from the public on how present technology should be treated within the description of telephonic or telephonic quality communication in the definitions of local and toll telephone service under section 4252." See, Federal Register, July 2, 2004, Vol. 69, No. 127, at Page 40345.

26 U.S.C. § 4251 provides that "There is hereby imposed on amounts paid for communications services a tax equal to ... 3 percent".

§ 4251(b) provides that the term ''communications services'' means "(A) local telephone service; (B) toll telephone service; and (C) teletypewriter exchange service".

26 U.S.C. § 4252 provides further definition of these three terms. It defines "local telephone service" as "(1) the access to a local telephone system, and the privilege of telephonic quality communication with substantially all persons having telephone or radio telephone stations constituting a part of such local telephone system, and (2) any facility or service provided in connection with a service described in paragraph (1)".

§ 4252 defines ''toll telephone service'' as "a telephonic quality communication for which ... there is a toll charge which varies in amount with the distance and elapsed transmission time of each individual communication ..."

The IRS notice asserts that "questions have arisen" regarding how to apply the statute to "communications services that were not available in 1965". The IRS notice does not disclose that the Congress has repeatedly amended § 4251 since 1965 -- 14 times. Yet, the Congress has not expanded the scope of the tax in these revisions.

In contrast, when the Congress has amended various other statutory provisions affecting communications it has often amended the list of technologies covered by those provisions. For example, as new communications technologies have been deployed, the Congress has repeatedly amended the statutes regarding wiretapping, interception and surveillance, in such acts as the Wiretap Act, the Electronic Communications Privacy Act (ECPA), the Communications Assistance for Law Enforcement Act (CALEA), and most recently, in the USA PATRIOT Act.

The recent history of legislative consideration of the excise tax on telephones in different. The only question that the Congress has closely examined is whether or not to entirely repeal the tax.

There were substantial efforts in the 105th,106th and 107th Congresses to repeal this tax. See, for example, HR 3648 in the 105th Congress, HR 3916 in the 106th Congress, and HR 236 in the 107th Congress,  The House passed HR 3916 on a roll call vote of 420-2, on May 25, 2000. See, Roll Call No. 233. However, the full Senate did not pass the bill. HR 236 had 149 sponsors.

In the present Congress (108th), there is a bill to repeal the tax, HR 2957.

The IRS assertion that "questions have arisen concerning the application of section 4251 to certain communications services that were not available in 1965" is thus arguably inconsistent with the relevant legislative history. The IRS does not provide further elaboration on this point.

The IRS notice also states that "A tax on communications services has existed for over 100 years." Former House Majority Leader Dick Armey (R-TX) used to give speeches in which he stated that this tax was imposed to finance the Spanish American War. He would add that he had recently spoken with the Spanish Ambassador, who assured him that the war is over. Hence, Rep. Armey (at right) argued, the tax should now be repealed.

Senate Report 106-328 on HR 3916 states that "The first tax on telephone service was enacted in 1898 to help finance the Spanish-American War. That tax was repealed in 1902 and was not re-enacted until World War I required additional revenues. The World War I telephone tax was repealed in 1924 and was re-enacted in 1932. All of these initial telephone taxes applied only to toll (long distance) service. In 1941, with the advent of World War II, the tax was extended to general local service. An excise tax on telephone service has been in effect in every year since 1941, despite enactment of periodic legislation to repeal or phase-out the tax." (Parentheses in original. Footnotes omitted.)

Moreover, 26 U.S.C. §§ 4251 and 4252 are drafted in contemplation of a circuit switched system in which common carriers bill their customers for local and long distance telephone services. The IRS notice provides no notice of how it might attempt to assess and collect excise taxes on these new "communications services" that "reflect changes in technology".

For example, the statute provides that "The tax imposed by this section shall be paid by the person paying for such services". That is, the carrier (or service provider) does not pay the tax. It collects the tax from its customers, on its monthly bills, as a percentage of taxable services provided, and forwards collections to the IRS. Thus, the carrier or service provider must first know who the user is. For example, an old fashioned telephone common carrier, or other service provider, may provide broadband internet access service to a customer, who then separately acquires and installs software on the customer computer that enables VOIP communication with other users of that VOIP technology. The carrier or service provider may not know who is using which applications. The IRS notice does not state how it would impose an excise tax in this situation.

Any efforts by the IRS to compel reporting or disclosure by users of new technologies would not only be burdensome on them, and inhibit adoption of new technologies, it would also raise issues of privacy and security. See, related stories: titled "Sen. Grassley Condemns IRS for 2,300 Missing Computers" in TLJ Daily E-Mail Alert No. 342, January 9, 2002; "IRS Loses More Computers, Jeopardizes Taxpayer Info" in TLJ Daily E-Mail Alert No. 493, August 16, 2002; "GAO Report Finds That Computer Weaknesses At IRS Put Taxpayer Data At Risk" in TLJ Daily E-Mail Alert No. 673, June 4, 2003; and "IRS Data Vulnerable" in TLJ Daily E-Mail Alert No. 145, March 16, 2001.

Also, IP based services would not fit the statute's definitions of either "local telephone service" (since they are neither local nor telephone), "toll telephone service" (since there is no "toll charge which varies in amount with the distance and elapsed transmission time of each individual communication"), or "teletypewriter exchange service". The IRS notice does not state what new communications services or technologies would be subject to taxation, or what rationale the IRS might offer for extending the excise tax to them.

Four years ago the House voted 420-2 to repeal this tax. Federal agencies that take action that is contrary to the will of many members of Congress, and which are required by law to give public notice of their actions, sometimes publish their notices during Congressional recesses and major holidays. The IRS published this notice on July 2, during a recess of both the House and the Senate.