IRS Releases Streamlined Procedures to Calculate Telephone Excise Tax Refunds
Tax Alert, January 2007

The IRS has streamlined the procedures for computing long-distance telephone tax refunds by prescribing standard “safe harbor” amounts for individuals, and issuing a simple formula that businesses and tax-exempt organizations can use to compute their refunds. These procedures are intended to minimize the compliance burden by providing simple methods that do not require taxpayers to locate and analyze 41 months of old phone records to determine the actual amount of tax that may be claimed as a credit.

Background

The Internal Revenue Code generally imposes a 3 percent excise tax on amounts paid for local and toll telephone services. Toll telephone service means a telephonic quality communication for which there is a charge that varies in amount with the distance and elapsed time of each individual communication and for which the charge is paid within the United States.

Historically, the excise tax applied to typical long-distance phone services because the telecommunications industry generally used pricing systems that included distance as a factor when charging for services. In recent years, however, the industry has generally adopted flat-fee or per-minute billing practices that may vary for calls that are local, intrastate, or interstate, but are not otherwise based on distance. As a result of these changes, a number of taxpayers argued that the excise tax should not be imposed on long-distance services under which charges were not based directly on a distance factor.

After suffering losses in several federal circuit court of appeal cases over the past two years, the IRS finally conceded this issue. In May of last year, the IRS announced that it would no longer require phone companies to collect the federal excise tax on most long-distance telephone services, and would issue refunds for the taxes paid for the period that began on March 1, 2003 and ended on July 31, 2006.

Nontaxable Telephone Services

The new procedures explain how to obtain refunds for excise taxes paid on nontaxable services, which include most long-distance plans as well as “bundled” services. A bundled service is a plan that includes both local and long-distance services but does not separately state the charge for local service. It includes Voice over Internet Protocol (VoIP), prepaid telephone cards, and plans that provide both local and long-distance services for either a flat monthly fee or a per-minute rate.Bundled service plans may involve both landline and wireless service.

“Local only” telephone service that is not bundled with long-distance service is still taxed at the 3 percent rate. Legislation that would eliminate this tax as well has been proposed in Congress but has not been enacted.

Claiming Your Refund

Both business and individual taxpayers may obtainer funds for excise taxes paid on nontaxable services for the period that began on March 1,2003 and ended on July 31,2006 by claiming the amounts actually paid as credits on their 2006 income tax returns. Taxpayers must generally be able to substantiate the amount of excise tax charged by the telephone service provider with bills or other records.

Individual taxpayers (but not companies) will be given the option of claiming a standard “safe harbor” credit, without having to support the amount with documentary evidence. The standard credit amounts for individuals who choose this option are based on the number of personal exemptions claimed on their 2006 tax returns — $30 for one personal exemption,$40 for two exemptions,$50 for three exemptions, and $60 for four or more exemptions. If a dependent has filed a separate request for a refund of the tax, that dependent is not included when calculating the taxpayer’s standard credit amount.

Who can claim the standard credit? In general, any individual who paid for nontaxable services that were billed after February 28, 2003 and before August 1, 2006 may claim the standard credit amount if the individual paid for all excise taxes billed by the telecommunications provider during this period.Taxpayers who do not otherwise need to file an income tax return may request a refund by filing Form 1040EZ-T.

Businesses and tax-exempt organizations can claim a credit based either on the actual excise tax paid or can calculate their refund using the “Estimation Method” developed by the IRS. The Estimation Method requires taxpayers to first determine the amount of excise tax paid on their phone bills dated in April 2006, which includes the excise tax for both local and long-distance service. This amount is divided by the total phone bill to determine the percentage attributable to the federal telephone excise tax. The same calculation is applied to phone bills dated in September 2006, which includes only the tax applicable to local service. The difference between the two percentages is then multiplied by the total telephone expenses for phone bills dated from March 1, 2003 through July 31, 2006 to estimate the total excise taxes paid for the entire 41-month period attributable to exempt services. Taxpayers can compute their total telephone expenses for this period based on the amounts reported as business-related telephone expense on their 2003 through 2006 tax returns. The telephone expense for a particular year is pro-rated if part of the year falls outside the refund period. The refund is capped at 2 percent of phone expenses for businesses with 250 or fewer employees and 1 percent for large businesses (with more than 250 employees).

Who can use the Estimation Method? In general, businesses and tax-exempt organizations that were operating at any time during the period from March 1, 2003 through July 31, 2006 may use the method if they incurred phone expenses from April through September 2006. This includes corporations, S corporations, partnerships, trusts, and estates. Nonprofit tax-exempt organizations can also use the formula. In addition, individual owners of rental property and self-employed individuals can use the formula, but only if they report gross rental and business income totaling more than $25,000 on their 2006 federal income tax returns.

Potential Refund

This refund opportunity will benefit almost all tax payers that have paid for long-distance telephone services since2003.However,most refunds will not be substantial. For example, if your business spent a total of$100,000 on nontaxable services during the refund period, it would be eligible for a $3,000 refund for taxes imposed at the statutory 3 percent rate. The amount refunded will generally be taxable since the taxes paid were deducted as part of your business telephone expense.

It is expected that many taxpayers will take advantage of the safe harbor procedures to calculate their refunds because the time and expense of determining the actual tax paid could exceed the amount of the actual refund. Many taxpayers will not be able to locate telephone bills for all of the periods in question and may have difficulty obtaining older bills from their service providers. Moreover, the bills might require detailed analysis to determine the amount of tax that should be refunded because many statements do not distinguish between the amount of tax paid on local and long-distance services. For these reasons, it may be more beneficial to utilize the streamlined safe harbor procedures provided by the IRS.