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Tax Foundation Brief: Stopping the IRS’s Revival of an Obsolete Tax

2 min readBy: Joseph Bishop-Henchman, Chris Stephens

In 1898, the United States went to war with Spain and enacted an excise taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. on telephone service to help pay for it. Repealed in 1902, re-enacted in 1917, repealed in 1924, and re-enacted in 1932, the tax was “temporarily” extended a further 29 times until it was made permanent in 1990.

In all other respects, the substantive provisions of the federal excise taxAn excise tax is a tax imposed on a specific good or activity. Excise taxes are commonly levied on cigarettes, alcoholic beverages, soda, gasoline, insurance premiums, amusement activities, and betting, and typically make up a relatively small and volatile portion of state and local and, to a lesser extent, federal tax collections. on telephone service has not changed since 1966. The tax is imposed on (1) local telephone service, (2) long-distance telephone service where price varies by distance and elapsed time, and (3) teletypewriter exchange service. Technological advances and changes in telephone habits have rendered teletypewriter exchanges obsolete, and long-distance service is now priced on time or in bundled services, rather than the per-call time and distance defined by the statute.

After losing a series of court cases, the IRS conceded in 2006 that the only remaining relevant portion of the tax is the tax on local telephone service. The IRS no longer attempts to collect the tax on other telephonic communications, recognizing that the rest of the statute is a vestige of a bygone era.

However, in 2007, the IRS demanded $16 million in back telephone excise taxes from bankrupt company WorldCom for data stream services related to its provision of dial-up Internet access in the early 2000s. The IRS contends that these services are “local telephone service,” while WorldCom argues that it is a communications service outside the scope of the statute. The Bankruptcy Court ruled for WorldCom, as did a federal judge, noting that the service was an intermediate service (not an end user service) and not telephonic-quality communication.

The federal Second Circuit Court of Appeals reversed, holding (1) that elements of the service could provide telephonic-quality communication, (2) that the IRS decision not to apply the tax to most communications services was not entitled to judicial deference, and (3) that to hold otherwise would produce “a strange result” of some services being taxed but not others.

WorldCom has appealed this decision to the U.S. Supreme Court, and the Tax Foundation filed a brief in support of the petition on May 21, 2014, requesting the Court to take the case.

Our brief makes two main points:

  • The Court’s guidance is needed to prevent the Internal Revenue Service from reviving a tax that was bad policy to begin with and was never intended to be a permanent tax, acknowledging recent court decisions and IRS rulings limiting the scope of the tax to local telephone service.
  • The courts should decline to expand the definition of “local telephone service” to new services not contemplated at the time of enactment, absent further congressional authorization.

Read the full brief here. See our page on the WorldCom case here.

The case is WorldCom, Inc. v. Internal Revenue Service, No. 13-1269.