IRS notice sparks VoIP taxation fears

Agency seeks input on significant changes in telecom industry but says it never planned to target Net phone services.

Declan McCullagh Former Senior Writer
Declan McCullagh is the chief political correspondent for CNET. You can e-mail him or follow him on Twitter as declanm. Declan previously was a reporter for Time and the Washington bureau chief for Wired and wrote the Taking Liberties section and Other People's Money column for CBS News' Web site.
Declan McCullagh
4 min read
An IRS notice affecting a longstanding telecommunications tax drew fire from a senior Republican on Capitol Hill, amid concerns that changes might affect emerging Internet phone services.

Rep. Chris Cox, R-Calif., sent a letter Wednesday to President Bush asking him to "direct the IRS immediately to affirm that this 100-year-old tax does not apply to the Internet, but only to traditional analog voice services."

"If IRS analysis suggests that (affirming) this will prevent Washington from raising new revenue from this tax, that would be very good news for American consumers--and more than 100 years overdue," wrote Cox, the fourth-most-senior Republican in the House of Representatives.

In an "advance notice of proposed rule-making" published Friday, the IRS and Treasury Department said they are considering whether the 3 percent federal excise tax should be reinterpreted "to reflect changes in technology" used in "telephonic or telephonic quality communications." After reviewing the notice, providers of voice over Internet Protocol (VoIP) technology said they were alarmed that they could be targeted.

Congress has been trying to eliminate the excise tax, which was first enacted in 1898 to pay for the Spanish American War. The House voted 420-2 to repeal it four years ago, but the Senate never acted.

"When it comes to consumer excise taxes, only alcohol and tobacco are taxed more heavily at the federal level than phone service," Cox wrote in his letter to Bush. "Telephone customers are then hit with state and local tax rates that can run up to three times the rates paid on other goods. That is why the House has voted to liberate consumers from this regressive tax."

Greg Jenner, acting assistant secretary for tax policy at the Treasury Department, tried to quell alarm over the notice--which asked for comments from the public--in a telephone interview late Wednesday.

"We are not considering taxing VoIP," Jenner said. "It simply is a request for comment. We can't conclude whether we're going to issue new regulations until we know what the industry has to say."

"We're tax lawyers," Jenner said. "As tax lawyers, we don't know technology. We know that the telephone industry has changed a lot. We don't know how, in all ways, shapes and forms. All we're doing is merely asking the industry to come in and talk to us...We have to understand the world, the industry, in order to interpret the law correctly, (especially) when you've got satellite phones and cell phones and all that."

Jenner, who is the Bush administration's top tax lawyer, added: "We know VoIP is out there. It's a nascent industry. It's not even clear that it's telecommunications. We can't make up the law. We have to take the law as it is and see what the world is and see how the two mesh. Does the statutory definition fit? I don't know...We're just simply asking to find out what the world is."

8x8, a small VoIP carrier based in Santa Clara, Calif., has been collecting the excise tax for several months based on advice from its attorneys, said 8x8 CEO Bryan Martin. The 3 percent fee averages an extra 65 cents per bill, which "is not a big deal," he said, adding that several other VoIP providers are doing the same thing.

Martin said that while the economic effect on a bill might be relatively small at present, the percentage carriers must pay can be increased to damaging amounts, like the 10 percent increase imposed during the Vietnam War.

"Three percent is no big deal," Martin said. "But 10 percent could be a real, real pain for a lot of people." The excise tax zoomed even higher, to 25 percent, during the height of World War II.

The IRS and Treasury Department announcement comes as Congress is taking a serious look at VoIP regulation and taxation for the first time. A bill introduced Tuesday would submit Internet phone providers to many of the same rules that apply to traditional voice carriers, and a hearing on Wednesday showed that some Democratic members of a key House panel favor that approach.

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 and about 600,000 VoIP subscribers. Corporations are gravitating toward VoIP even faster than consumers. It's estimated that as many as one in 10 business calls are now being completed entirely over the Internet.

Current law permits the IRS to levy 3 percent taxes on "communications services," including local telephone service and toll telephone service. Friday's announcement states that "questions have arisen concerning the application of (that law) to certain communications services that were not available" when the law was revised in 1965.

CNET News.com's Ben Charny contributed to this report.