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February 5, 2007

Tax Alert
Telephone Excise Tax Refund

Dear Clients and Friends of the Firm:

By now, you’ve probably heard that the IRS has to stop collecting certain telephone excise taxes and refund a portion of prior collections to the public. You generally have to claim it on your 2006 tax return. We are pleased to calculate the refund and prepare the claim for you. This memo summarizes some of the issues, and page 2 describes what information we need from you.

What excise tax?
In 1965, Congress amended the Internal Revenue Code to impose an excise tax on long-distance phone charges that vary according to distance and time. At that time, the phone company structured its charges based upon its historic costs of building a nationwide phone system—which meant that the longer the distance, the more wires and switches, and the higher cost.

With the advent and growth of cell phones, changing technology and increasing competition, long-distance charges evolved to be time-based only. Distance no longer mattered. The Treasury Department tried to change the rules for the excise tax, to have it apply to all long-distance charges whether or not by distance, but a handful of taxpayers objected and brought the IRS to court. After losing in court five times, the IRS capitulated. They have agreed not to collect the tax from phone companies after July 2006 and will allow refunds for the tax you paid after February 28, 2003 and before August 1, 2006.

The excise tax on local phone service stays in place.

How much can you get?
It’s a laborious calculation, but the IRS offers a simple shortcut that gives a close approximation.

The exact and laborious calculation
Take out all your original phone bills dated after February 28, 2003 and before August 1, 2006 (41 monthly bills), calculate each month’s federal long-distance excise tax, add them together, and that’s your total.

The simplified calculation
The IRS has published a formula that lets us calculate the excise tax refund based upon two monthly bills instead of 41 monthly bills. It’s a simple calculation (albeit with a lot of entries), and one that most businesses can perform.

• Determine the total amount you paid for telephone services for the 41 month period (March 2003 through July 2006). If you don’t have your phone bills broken down by month, assume that your monthly bill for 2003 is one-twelfth of your 2003 phone expense, and likewise for 2004, 2005 and 2006. Fill in Worksheet I (see page 4).
• Collect your phone bills for each telephone billing account you have for April 2006 and September 2006. If you have more than one billing account, add the amounts for each bill together to get the total amount for that month. Fill in Worksheet II (see page 5). Note that in Worksheet I, you could assume that each month is one-twelfth of the yearly bill, but in Worksheet II, you must use the actual numbers from your April 2006 and September 2006 bills.
• Send Worksheet I and Worksheet II back to us.

Safe Harbor amount for individuals
There’s a safe harbor amount for individuals, so you don’t need to give us copies of your personal telephone bills. The IRS bases the safe harbor amount on the number of exemptions you claim on your 2006 federal income tax return. So, if in 2003–2005 your children were racking up long-distance calls and by 2006 they’ve moved out and aren’t your dependents, you suffer. If on the other hand, you had more children in 2006 than in 2003–2005, you benefit. Considering that the safe harbor varies between $30 and $60, the detriment or benefit is not crucial. Here are the amounts:

The safe harbor amounts include presumed interest on your refund.

How do you make a claim?
You can make the claim on your 2006 tax return (for fiscal-year businesses, that’s the year that includes December 31, 2006), or you can ask your long-distance company to give you a refund. Obviously, you can’t do both. Your long-distance company isn’t required to process these claims, so you have to determine its policies before investing the time and trouble. Additionally, you have no way to guarantee that your long-distance company will expeditiously process your claim and grant your refund, and if they drop the ball, it may be too late to claim a refund from the IRS.

If you are a business, prepare the worksheet above, send it to us and we will prepare the necessary federal Form 8913 for you.

If you are an individual claiming the safe harbor, there is space on Form 1040 to claim the refund, which we will complete for you using the safe harbor method. If you want to change from safe harbor to actual calculation at a later time, you must file an amended return (generally within three years).

Records you must maintain
An individual claiming the safe harbor doesn’t need to retain any records. For businesses and any individual not claiming the safe harbor, you must retain all your bills and proofs of payment (e.g., canceled checks).

Further questions
Please contact us if you have any further questions about the excise tax refund.

Worksheet I

Worksheet II

For information contact:

Alisa Morris
Director of Marketing
(212) 303-1880
amorris@rssmcpa.com