Final regs. on excise tax treatment of prepaid telephone cards.

The IRS recently issued Regs. Sec. 49.4251-4, dealing with the application to prepaid telephone cards (phonecards) of the Sec. 4251 3% Federal excise tax. The tax is imposed on amounts paid for communications services, which include "local telephone service" and "toll telephone service." The excise tax is generally paid by the person paying for services, and is to be collected and remitted to the Service by the person receiving payment for the services.

Phonecards are the physical embodiment of a right to a certain amount of communications services from a particular communications service provider. A card can represent the right to a certain number of minutes of service, or a certain dollar-value of service whose rate can depend on time of day, location, distance and duration of a call. The amount for which the services are sold by the carrier bears no particular relationship to the retail price of the card, and it may go through one or more wholesalers before it is sold at retail.

The phonecard industry expanded rapidly in the early 1990s, raising many issues about how the Federal excise tax should be paid and collected. Sec. 4251(d) was enacted in 1997 to provide some definite rules, effective for amounts paid on or after Nov. 1, 1997, with no inference intended as to the proper tax treatment of such cards under prior law:

* When communications services are acquired by use of a prepaid telephone card, the tax is treated as paid at the time the card is transferred by a telecommunications carrier to any person who is not such a carrier (Sec. 4251(d)(1)(B)). Thus, the telecommunications carrier would be responsible to collect the tax on that transfer and remit and report it to the IRS.

* The "face amount" of the card is treated as the amount paid for the communications service and, thus, the amount subject to the 3% tax (Sec. 4251(d)(1)(A)). The face amount is not necessarily the amount paid for the card by the user or any intermediary. The statute left it up to regulations to determine the "face amount" of a card without a stated dollar amount of use.

Regs. Sec. 49.4251-4 is effective for cards transferred by carriers on or after April 1, 2000 (although taxpayers may apply the regulations earlier). Sec. 4251 (d) applies only to cards that permit the holder to obtain a fixed amount of communications services by means of a code (such as a PIN) or other access device provided by the carrier and to pay for those services in advance. Thus, a phonecard that enables the holder to make unlimited calls at a certain rate, and to pay for the calls made later, is not subject to Sec. 4251(d). A carrier is not responsible for collecting the tax if, at the time of transfer, it has received written notification, signed under penalties of perjury, that the purchaser is a carrier and it has no reason to believe otherwise. If a purchaser that is not a carrier provides such a statement to a carrier, the purchaser remains liable for the tax. If the carrier transfers the card to a non-carrier without receiving any payment, there is no Sec. 4251 (a) tax.

Regs. Sec. 49.4251-4 deals primarily with defining what constitutes the taxable "face amount" of a card. In the case of cards with a value designated by the carrier in dollars, the "face amount" generally is:

* In the case of cards that are for a certain number of units (e.g., minutes) without a designated dollar value, where the retail price will not exceed the Federal Communications Commission scheduled tariff rate for the communication, the face amount generally is equal to the tariff rate for the units.

* In the case of other cards (so-called "untariffed cards"), if they are sold directly to a person who does not purchase the card for resale, the face amount generally is the sales price.

* In the case of untariffed cards sold to a person who purchases them for resale, the face amount can be whichever of the following the carrier chooses:

1. Generally, the highest price at which the carrier sells a single card to a user for comparable service;

2. 135% of the sales price (including any contingent amount per unit) to the transferee reseller (if the sale is not at arm's length, the retail fair market value of the card will be used instead of 135% of the sales price); or

3. For cards ordinarily used entirely for domestic communications service, a flat per-minute rate of 30 cents. The flat rate is reduced, under a formula, if the maximum time is at least 60 minutes, down to a 20 cents per-minute rate if the card provides 240 or more minutes of service.

The Service rejected a suggestion that a carrier be allowed to use the card's actual retail sales price as its face amount, if the carrier can substantiate that amount. The IRS was concerned about the difficulties of verifying such an amount, and believes that the face amount determined under these regulations does not overstate value.

FROM DAVID P. CULP, J.D., CPA, ROBERT M. BROWN, J.D., LL.M., CPA, AND C. ELIZABETH WAGNER, J.D., CPA, WASHINGTON, DC