Court Reinstates IRS Phone Tax Refund Suit

(CN) - Quoting a comic-strip writer, the D.C. Circuit revived a class action challenging the IRS' convoluted scheme for refunding the $8 billion it improperly collected in excise taxes on long-distance phone calls.

"Comic-strip writer Bob Thaves famously quipped, 'A fool and his money are soon parted. It takes creative tax laws for the rest,'" Judge Brown wrote in the ruling's introduction. "In this case it took the IRS's aggressive interpretation of the tax code to part millions of Americans with billions of dollars in excise tax collections.

"Even this remarkable feat did not end the IRS's creativity," Brown continued. "When it finally conceded defeat, the IRS got really inventive and developed a refund scheme under which almost half the funds remained unclaimed."

The IRS collected the 3 percent excise tax through telephone service providers. The system worked well when phone companies based their billing on a call's duration and distance, but the introduction of cell phones made distance-based billing obsolete. Phone companies began charging strictly based on the length of calls.

Despite this shift, the IRS continued to collect taxes on long-distance calls. Several corporate taxpayers sued and won in five federal circuit courts, forcing the IRS to issue a refund notice.

The notice told taxpayers to request their refund on their 2006 federal income tax returns. Taxpayers could either request a "safe harbor" amount, or they could seek the actual amount of the taxes they paid, for which the IRS could demand documentation.

Taxpayers again sued over the refund process, claiming it was too cumbersome and discouraged them from getting their money back.

The district court dismissed taxpayers' procedural claims, but the Washington, D.C.-based appeals court reversed.

Tax code usually strips courts of jurisdiction over refund claims, but the appellate panel noted that "this case is different: the fight is over process, not disputed funds."

After establishing jurisdiction, the court rejected the IRS' bid to dismiss, which the government claimed was necessary because the refund notice was a general policy statement, not a binding rule.

"In sum, the IRS unlawfully expropriated billions of dollars from taxpayers, conceded the illegitimacy of its actions, and developed a mandatory process as the sole avenue by which the agency would consider refunding its ill-gotten funds," Brown wrote.

"It cannot avoid judicial review of that process by simply designating it a policy statement."

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