Federal Judge Allows Class Action Over IRS Refund Notice to Proceed

Shannon P. Duffy

The Legal Intelligencer

Dealing another major setback to the IRS in the ongoing litigation over how it handled a massive $8 billion refund for a now-abandoned telephone excise tax, a federal judge in Harrisburg, Pa., has refused to dismiss a nationwide class action suit that says the agency's public notices about the availability of the refund violated due process.

The ruling in Swisher v. United States by U.S. District Judge John E. Jones III of the Middle District of Pennsylvania comes on the heels of a scathing decision in August from a federal appeals court in Washington, D.C., that revived a batch of similar suits alleging that the IRS' handling of the refund program violated the Administrative Procedures Act.

Both rulings are victories for attorneys Benjamin F. Johns, Nicholas E. Chimicles and Morris M. Shuster of Chimicles & Tikellis in Haverford, Pa., who serve as lead counsel in the Pennsylvania case and on the executive committee for the class of plaintiffs in the Washington, D.C., case.

The suits stem from a wave of litigation in which some of the biggest corporate taxpayers successfully challenged the 3 percent excise tax on long-distance telephone service.

Taxpayers won a string of decisions in which courts ruled that the long-distance excise tax, created to pay for the Spanish-American War in 1898, simply didn't apply to modern technology.

The law had authorized a tax on long-distance telephone service that is billed according to both the distance and the elapsed time of the call. But over time, telephone companies had changed their billing methods, and by 2003, they no longer billed their long-distance customers' calls according to distance and elapsed time.

The IRS conceded defeat after more than a dozen companies, including Hewlett-Packard Co. and Amtrak, won hefty refunds from the government.

In May 2006, the IRS announced that it would stop collecting the tax and would establish a program to provide refunds for the 41 months in which the tax was unfairly included on telephone bills.

Tax forms for 2006 included a line in which taxpayers could claim standard refunds ranging from $30 to $60, with the option of providing documentation to prove that a greater refund was due.

For those telephone customers who, for whatever reason, were not required to file a return, the IRS created a new form, the 1040EZ-T, to claim the refund.

Now the IRS is mired in another wave of litigation as taxpayers challenge the refund program as unfair, inadequately publicized, and designed to limit the number of refunds paid.

The Treasury Inspector General for Tax Administration found in 2007 that only about $3.8 billion of the $8 billion improperly collected by the IRS was actually paid back in refunds.

U.S. District Judge Ricardo M. Urbina dismissed three consolidated suits in 2008, but the U.S. Court of Appeals for the D.C. Circuit revived the cases in August 2009 with a blistering opinion that sharply criticized the IRS for using "creative" tactics to avoid paying refunds to all those eligible.

"When it finally conceded defeat on the legal front, the IRS got really inventive and developed a refund scheme under which almost half the funds remained unclaimed," D.C. Circuit Judge Janice Rogers Brown wrote in In re Long-Distance Telephone Service Federal Excise Tax Refund Litigation.

Brown said the IRS was trying to dodge responsibility under the Administrative Procedures Act by arguing that the refund scheme was "not a binding rule but only a general policy statement." Rejecting that argument, Brown wrote: "We conclude the notice bound the service, tax collectors and taxpayers. Accordingly, we reverse the district court's dismissal of appellants' claims made under the Administrative Procedures Act." While the Washington, D.C., case was on appeal, the Pennsylvania suit was filed on behalf of a class of non-filers who say they paid the telephone excise tax on their monthly phone bills, but were effectively denied access to the refund program because the IRS provided minimal notice.

The suit alleges that because the IRS failed to provide the non-filers with reasonable notice of the availability of the excise tax refund that complies with due process, the number of non-tax return filers who actually claimed a refund was extremely low.

The Treasury Inspector General reported that only 800,000 of the 10 to 30 million non-filers who were entitled to a refund actually filed the required special form to claim their refund.

Justice Department lawyers moved for dismissal of the suit, arguing that the case was barred by the Anti-Injunction Act, or AIA, and that the non-filers were required to file administrative claims for refunds.

The 12-page decision by Jones closely tracks the rulings by Brown in the Washington, D.C., case.

"Although not binding on this court," Jones said, the decision by Brown "provides persuasive reasoning that we shall adopt." The AIA argument failed, Jones said, because the suit is not a refund suit.

Lead plaintiff Adam Swisher "does not seek a refund for the excise tax," Jones said, but instead "is contesting that the pertinent notices ran afoul of appropriate due process." As a result, Jones said, the relief sought in the suit does not "seek to restrain the assessment or collection of taxes, and the requested relief, if granted, could not result in impermissible restraints." For related reasons, Jones rejected the government's exhaustion argument, finding that the non-filer plaintiffs cannot be barred from suing solely because they failed to file an administrative refund claim.

Instead, Jones said, like the plaintiffs in the Washington, D.C., case, the non-filer plaintiffs are no longer seeking a refund but rather "seek to challenge the procedural obstacles the IRS inserted between the individual taxpayers and their right to file suit to recover unlawfully collected taxes." Professor Steve Johnson, who teaches tax law at the University of Nevada Las Vegas' Boyd School of Law, said the rulings by the D.C. Circuit and now by Jones are "important in a larger sense" because they show a trend on the part of "generalist courts" to hold the IRS and the U.S. Treasury to the same exacting standards for rule-making that apply to all federal agencies.

Johnson said he will be following both cases closely. He said the IRS and Treasury have been "prone to insularity," and that he considers the decisions that require the agencies to abide by the strictures of the Administrative Procedures Act and, as a corollary, the Due Process Clause, to be an "extremely good development." Justice Department spokesman Charles Miller declined to comment on Jones' decision, but confirmed that the government has filed a petition for rehearing in the Washington, D.C., case.