IRS eyes Net phone taxes

A tax first enacted in 1898 to pay for the Spanish-American War might be reinterpreted to apply to Internet phone calls.

A "temporary" tax created to pay for the Spanish-American War may result in higher fees for Internet telephone calls.

In a notice published Friday, the IRS and Treasury Department said they are considering whether an existing 3 percent federal excise tax on phone calls should be reinterpreted "to reflect changes in technology" used in "telephonic or telephonic quality communications."

Although the notice does not mention Net phone services, industry advocates warned it could lead to new taxes on fast-growing voice-over-Internet Protocol (VoIP) technology, depending on how it's interpreted.


What's new:
The IRS and the Treasury Department have suggested that an existing federal excise tax on phone calls should be interpreted to apply to Internet telephone calls.

Bottom line:
The move promises to roil the fast-growing VoIP industry and follows similar attempts by state officials to tax or regulate Net telephony.

More stories on this topic

"They're looking at VoIP and any other potential technologies that are flying under the radar," said Glenn Richards, a partner at the law firm Shaw Pittman in Washington who represents VoIP companies. "Clearly they're trying to extend their jurisdiction to apply the excise tax to as many 'calls' as they can. It's got to be a revenue issue for them. If everyone starts migrating to new platforms, they're facing a decrease in excise taxes."

IRS spokeswoman Tara Bradshaw said that the agency is in the "very beginning of the process" of updating its regulations on what is covered by the tax code's definition of telephone service. "We're just requesting information," she said. "We're not creating new rules at this point. We're just requesting comments."

The IRS notice opens up another, unexpected front in a burgeoning battle over the regulatory status of VoIP, which already has pitted state regulators against the Federal Communications Commission and has led the FBI to propose that wiretapping laws designed for the traditional phone network be extended to Internet voice communications. About 2.8 million people make phone calls over their broadband connection, a figure that includes about 2.2 million cable customers using circuit-switched technology. Roughly 600,000 people of the 2.8 million total use VoIP. Corporations are gravitating toward VoIP even faster than consumers, with as many as one in 10 business calls that once traveled over the traditional voice network taking place completely over the Internet.

Analysts expect significant growth in the sector for the next five years, especially now that Cox Communications and Comcast are committing more of their budgets to building up their VoIP services.

Those predictions worry state regulators, who say they fear losing tens of millions of dollars--from fees and subsidies provided by telephone companies--if more calls flow away from traditional phone networks and onto the Internet. States such as Minnesota and New York already are trying to seize authority over VoIP companies.

A tax that never dies
Congress enacted the so-called "luxury" excise tax at 1 cent a phone call back in 1898, when only a few thousand phone lines existed in the country. It was repealed in 1902, but was reimposed at 1 cent a call in 1914 to pay for World War I and eventually became permanent at a rate of 3 percent in 1990.

Former House Majority Leader Dick Armey repeatedly tried to repeal the tax during his tenure in Congress. In May 2000, the House of Representatives voted 420-2 for the repeal, but the Senate never acted on the measure.

"I think there's going to be a big backlash in Congress if they try to do this," said Armey, who is now chairman of the conservative group Citizens for a Sound Economy. "I don't think anybody could have legislated an application of the (Spanish-American War) surcharge to VoIP, and I don't think that Congress will allow the IRS to do it by fiat."

Tom Readmond, federal affairs manager for Americans for Tax Reform, said his group "has not yet weighed in, but obviously we would oppose extending telephone excise taxes to VoIP." The group asks politicians to sign a no-new-taxes pledge and has lobbied against Internet sales taxes in the past.

VoIP companies panned the IRS-Treasury notice.

"What they see is huge revenues, and whenever there's huge revenue, they are looking to tax," said Jeff Pulver, founder of Free World Dialup. He said that "even if it's decided the IRS can do what they want to, they should choose not to enforce it" and follow the hands-off approach recommended by Michael Powell, chairman of the Federal Communications Commission.

VoIP provider AT&T, which launched its CallVantage service 14 weeks ago, argued that VoIP "shouldn't be burdened by costs that would stifle its growth." The company is, however, willing to "comply with any applicable taxes," said spokesman Tom Hopkins.

Current law permits the IRS to levy 3 percent taxes on "communications services," which include local telephone service, toll telephone service and any "teletypewriter exchange service." Last Friday's notice says "questions have arisen concerning the application of (that law) to certain communications services that were not available" when the law was revised in 1965.

The IRS and Treasury Department notice, called an advance notice of proposed rulemaking, asks for comments from the public no later than Sept. 30. Bradshaw, the IRS spokeswoman, said "we're requesting the comments so we know what issues to look at."

CNET's Ben Charny contributed to this report.

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