My two cents (of Federal Excise Tax)

Last month, I was musing about my phone bill. One mystery was why I was being charged $0.02 more for the Federal Excise Tax than the 3% mandated. I called the phone company, but they were unable to provide any explanation. I asked the public utility commission, who provided the information below. The legal interpretation is the phone company is assessed local taxes and is permitted to use these in the base calculation for Federal Excise Tax.

http://www.wutc.wa.gov
Q. The city tax rate on my bill appears higher than the rate approved by the city government. In fact, it appears that the utility is asking me to pay a tax on a tax. Why is that?

A. A considerable number of cities and towns in Washington impose business and occupation tax on utilities doing business within their jurisdiction. These taxes are generally based on a percentage of the company’s revenues generated by their business within the particular city or town. Since 1947, Pacific Northwest Bell Telephone Company (now Qwest) “passed on” to the telephone customers residing in any such city or town, the effect of the municipal occupation tax imposed on the company. Other utilities, such as gas and electric, have also passed this tax to their customers. This practice is followed by all public utilities in the state.

Q. Is it legal to impose a tax on a tax?

A. The “effect of the city tax” is not legally viewed as a tax on a tax because the city is not taxing the individual customer but rather it is taxing the company (business and occupation tax). The amount shown on the bill as “Effect of City Tax” is not a tax on the customer at all, but a tax on the company which was allowed to be passed on to the customer by the commission.

Local utility taxes that are levied in Washington are imposed directly on the company and the company is solely responsible for its payment. There is nothing in local tax ordinances that permit the telephone company to pass on these taxes to the customer. It is state regulatory law, and the orders of the commission, that allow the companies to impose an additional service charge to cover the cost of administering these taxes (i.e., billing and collection). One rationale for this practice is so the commission and the customer can accurately determine what part of the local rates are due to local taxes.

The methods employed by the utility company to compute the federal excise tax on customers’ bills are mandated by state and federal law.

Q. Has this practice been upheld by the Washington State Supreme Court?

A. Yes. This procedure was first required in the Commission’s Fifth Supplemental Order in Cause No. F.H. 7229 issued on October 9, 1947. This order was later upheld by the Washington Supreme Court which held that these taxes were imposed on the telephone company rather than the customer in State ex. rel. Seattle v. Department of Public Utilities, 33 Wn2d 896, 207 P2d 712, 1949.

Q. What is the legal basis for allowing the practice of charging the increased “effect of a tax?”

A. Since this charge is not a tax, but a part of the telephone service charge, it is required to be included in the base for Federal excise tax purposes. Federal law requires that all charges included on the bill be included in the tax base.

Section 4251(a) of the Internal Revenue Code imposes the Federal excise tax on communications services. The tax applies to both local and toll service. This Section provides that the excise tax is to be paid by the person paying for the service, which is of course the telephone customer. Section 4254(a)(1) of the Code goes on to state that the amount on which the tax will be based will be the sum of all charges for the services included on the bill. No deductions are allowed on the basis of costs or expenses. Consistent with Section 4254(1)(1), the Internal Revenue Service has held that where a state or local taxing authority imposed a tax on the telephone company, rather than on the telephone company’s customer, and the effect of this tax is required or permitted to be passed on to the customer, then the tax is required to be included in the Federal excise tax base. This is true even though the effect of the tax may be shown as a separate item on the bill. Washington State has answered this question in court (see legal cite in previous paragraph).

Q. Has this issue been heard in the Federal courts?

A. Yes. Since these local taxes are imposed on the company rather than the customer, they represent costs of doing business. The effect of these costs are passed on as additional service charges for the company’s services. Under Federal Law (Section 4251), the company is required to compute the Federal excise tax by including all charges – including these additional service charges (i.e., effect of city taxes) – as part of the Federal tax base. This requirement has been upheld in Federal rulings dealing with similar state and local taxes in Rev. Rul. 77-472, 1977-2 CB 379; Rev. Rul. 73-184, 1973-1 CB 455; and Rev. Rul. 69-151, 1969-1 CB 288; and in the Federal courts in State of Minnesota et. al. v. U.S. et. al. 75-2 USTC para 16,204, 525 F2d 231 (8th Cir. 1975); and Agron v. Illinois Bell Telephone Co. et. al. 71-2 USTC para 16,014, 449 F2d 906 (7th Cir. 1971).