Wrangling for a refund

It's been about a decade since long-distance carriers began flat-rating their per-minute toll charges instead of charging according to mileage bands. But only recently have many network managers begun to realize that this move should have changed the way the carriers apply taxes.

Several dozen Fortune 500 corporations have filed requests with the Internal Revenue Service for refunds of the 3% federal excise tax on toll telephone service. Their argument: Under the law, the tax applies only to calls whose prices vary by time and distance. And hardly any interstate calls vary by distance now - a call from Chicago to Cincinnati costs the same as a call from Chicago to San Diego.

While the IRS officially disagrees with this argument and has often dithered with these requests, a federal court in Cleveland has ruled in favor of these types of refunds and might force the IRS' hand. In February the court issued a ruling that, if upheld on appeal, will force the government to refund more than $380,000 to OfficeMax because of excise taxes improperly collected since 1999 on the retailer's MCI long-distance bills.

The court ruling might spur similar refund requests from a range of corporate customers, especially because the stakes are huge. In 2002, the most recent reporting year, the U.S. government collected up to an estimated $2.51 billion from the federal excise tax on toll telephone service. By making claims that go back three years - the statute of limitations for this type of tax refund - companies in one fell swoop could recover up to 9% of their current-year spending on such long-distance tolls.

In a 1965 law that reformed the system of excise tax collection, Congress defined "toll telephone service" to mean "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." Without distance sensitivity, the tax no longer appears to apply.

Arguably, the federal excise tax was flawed from the beginning. In general, excise taxes are levies the government placed on non-essential goods. The telephone excise tax began in 1898 as a measure to help pay for the Spanish-American War. But telephone calls were a novelty then, so the charge was in effect a "luxury tax."

With the 1965 Excise Tax Reduction Act, Congress tried to eliminate the tax on numerous goods and services. Congress reduced the telephone tax from as high as 10% to 3%, but a further scheduled phase-out to zero was repeatedly postponed in budget negotiations, and the 3% rate was made permanent in 1990.