Phone Tax Suit Revived

A panel of the U.S. Court of Appeals for the District of Columbia ruled that taxpayers could challenge under the Administrative Procedure Act (APA) the IRS’ method of refunding long-distance telephone excise taxes.

The 2-1 decision in Neiland Cohen v. U.S. (docket no. 08-5088) reversed and remanded a dismissal of the case by the District Court for the District of Columbia. The appellate court’s opinion by Judge Janice Rogers Brown issued Friday sharply criticized the IRS’ position as “mean,” demonstrating “chutzpah” and demanding “clairvoyance” of taxpayers. The case had been consolidated with two others.

The 3% excise tax on phone service under IRC § 4251 had been challenged by a number of taxpayers with respect to toll calls. IRC § 4252(b) defines taxable service as including long-distance calls for which the charge varies with time and distance or is billed by a flat fee for calls within a specified nonlocal area. However, taxpayers argued, because of changes in telecommunications, distance-related charges no longer applied in most cases. After several circuit courts had ruled against the IRS, the Service in Notice 2006-50 announced it would stop collecting the tax on charges based solely on transmission time and provided a procedure for refunds. Taxpayers could claim refunds on their 2006 income tax returns for either actual taxes paid from 2003 to 2006 or a safe harbor amount (for individual taxpayers, between $30 and $60, depending on number of exemptions).

The district court ruled that Cohen had not met the requirements of section 7422, which generally bars any refund suit until an administrative claim has been filed. On appeal, Cohen argued that the refund scheme violated the APA, which is codified under Title 5 of the U.S. Code starting at section 500. Notice 2006-50 could be reviewed under the APA because it was a final agency action resulting from IRS deliberations and altered the legal rights or obligations of the Service, tax collectors and taxpayers, the court said. As such, it constituted more than a mere statement of policy under which the IRS exercised discretion, as the Service had argued at trial, particularly since it amounted to an admission that the taxes had been illegally collected, the court said.

As for the Service’s argument that taxpayers were not required to follow the notice to file suit, “that’s just mean,” Brown wrote, citing a “virtual house of mirrors” of contradictory form instructions. Likewise, she wrote, filing an informal claim to satisfy the statutory requirement, as the district court had suggested, would likely have ended in frustration.

“Despite the obvious infirmities of these options, the IRS still has the chutzpah to chide taxpayers for failing to intuit that neither the agency’s express instructions nor the warning on its forms should be taken seriously. … Taxpayers bear a heavy burden when pursuing refund claims, but we have yet to demand clairvoyance,” she wrote.

In a dissenting opinion, Judge Brett M. Kavanaugh acknowledged the plaintiffs’ complaints that they were undercompensated by the refund scheme. However, they did not properly seek refunds within that scheme or the administrative exhaustion requirements of sections 7422(a) and other provisions rejected by the majority that have been repeatedly upheld by the courts, he said.

“The question here concerns only the timing of judicial review, not the availability of judicial review,” Kavanaugh wrote.