OLYMPIA, April 18.—A court case on cell-phone taxation that once threatened to rip a billion-dollar hole in the state budget has been settled quietly by the Department of Revenue, but the state’s effort to square things raises the possibility of a whole new round of litigation from Washington cable companies. Lawmakers managed to avoid the issue this year, but it sounds like they’re eventually going to have to settle the argument.

Here’s the $40 million question: If traditional telephone companies don’t have to charge sales tax for residential landline telephone service, what about cable companies that provide the same type of service? You don’t notice a difference when you pick up the receiver and hear a dial tone. But the Department of Revenue says cable companies ought to pay, while traditional phone companies don’t have to.

Just goes to show that sometimes you can try to fix one problem and create a whole new one in the process. Also, that there have been changes in the telephone industry no one dreamed of 30 years ago. And that sometimes the state has a mighty curious way of trying to fix things after the fact.

Anyway, this one isn’t over yet, and you can watch for it to resurface next session. If you’re among those who continue to use a landline phone of some type, you have two or three bucks a month riding on the outcome.

Whatever Happened to the ‘Sprint Bill?’

The Department of Revenue rushed to the statehouse with an urgent piece of legislation last November, on the first day of the special session that really kicked off this year’s season of lawmaking. If it didn’t get an unusual retroactive rewrite of state tax law, DOR said the state and local governments might be on the hook for a billion dollars. That’s billion, with a “b.”

What happened is that a judge last year in Thurston County ruled in favor of cell-phone provider Sprint last in a tax lawsuit against the state. The company argued that so many phone customers had ditched their old landline telephones in favor of cell phones that really cell phones ought to be considered residential telephone service. And if that was the case, then Sprint ought to qualify for a tax break that was written into state law years ago.

In 1983, the state imposed sales tax on phone bills, but it exempted basic charges for the “residential class of telephone service.” Back then, of course, all residential phones were the sort you plugged into the jack on the wall. The idea was that the exemption would help keep costs low and encourage “universal service.”

Then the business changed. Cell phones had just come on the market in 1983, but they were the size of a brick and they were so expensive that they were used mainly by captains of industry, corporate chieftans and status-seeking yuppies. Over the years cell phones became cheaper and smaller and snagged a bigger and bigger market share. Cell phone companies charged sales tax. But by 2007, when Sprint filed its lawsuit, the company maintained you really couldn’t tell the difference between a cell phone and a home phone. It was one of those cases that took years, but finally the judge agreed.

The ruling, if taken to the extreme, would have been immensely costly. If the state couldn’t impose the tax on cell phone providers, it also would have to provide four years of refunds – a $739 million hit in the current two-year budget period, and an ongoing hit every budget after that. In 2013-15 the state would lose $331 million. Local governments get sales tax, too, and so they’d take a hit of their own – $280 million in the current budget cycle, and about $130 million every two years thereafter.

The department wanted a bill that stated the Legislature had always intended to limit the exemption to plain old telephone service, the sort of wired telephones that are regulated by the state Utilities and Transportation Commission. An alarmed House Ways and Means Committee immediately passed HB 2128, the so-called “Sprint bill.” And then – nothing. Really, not a peep for the rest of the legislative session. The bill died.

A Quiet Settlement

The issue fell off the radar screen because while the session was in progress, the Department of Revenue settled with Sprint. The terms of the settlement are undisclosed, said DOR spokesman Mike Gowrylow, except for one piece of public information. In February the ruling in Thurston County Superior Court was vacated.

“While we were confident we would have prevailed on appeal, we chose instead to resolve the disagreement with Sprint a few months ago,” Gowrylow said. “It is done. What part of the settlement did was to vacate the Thurston County Superior Court ruling, so it is gone, it doesn’t trouble us anymore, and under that settlement Sprint will continue to collect sales tax on residential cellular service just as it had been doing in the past.”

DOR sees one big problem. Any other cell-phone provider might file suit. It’s a vulnerability that has been exposed by the Thurston County ruling, and the Legislature still needs to pass some type of clarifying legislation, Gowrylow said. “We believe that it only applies to tarrifed landline service, but the risk remains until a court issues a final decision or the Legislature moves to update this 1983 exemption.”

Cable Companies Concerned

DOR isn’t the only entity that is worried. Its plan entails what looks like an after-the-fact change to state tax law, and it could slam cable companies hard. Over the last decade they have begun offering landline service of their own, but it’s not quite the same thing that the traditional telephone companies offer. What they sell is called Voice over Internet Protocol, or VoIP. Because calls are routed over the Internet via cable modems rather than phone lines, they aren’t subject to UTC regulation. The cable companies have 800,000 residential customers statewide, and they haven’t been charging sales tax, either. Their contention is that the 1983 law means exactly what it says – residential telephone service is residential telephone service, period, end of story.

And so things get awfully tricky. DOR maintains that nothing has changed, and the exemption has always been limited. Since 2004, it has been issuing “excise tax advisories” that say the exemption applies only to state-regulated phone service. That “clarification” was aimed at staving off lawsuits like the one Sprint managed to win. Cable companies say it was only when the Sprint case got hot that DOR told them they were on the hook, too. But they still aren’t paying.

If DOR gets a retroactive fix, then cable providers could be liable for years of back taxes. And moving forward, cable phone customers would see an extra two or three bucks a month tacked onto their bills for sales tax, while customers of traditional phone companies would not.

A solution surfaced in the final days of this year’s session. In the initial version of the year’s big tax bill, SB 6635, a conglomeration of tax-break extensions and repeals, one provision extended the sales tax to all forms of telephone service. That seemed fair all the way around, cable companies argued. Everyone would compete on an equal footing, and for the state, it would have meant an additional $40 million a year. But as you might expect, traditional phone companies didn’t like it much, and members had misgivings as well. So the proposal was dropped. You have to think about the sort of people who still use landline phones, said Ed Orcutt, R-Kalama, the House Republican lead on tax policy. They’re the elderly and residents of rural areas where cell phone service is spotty. “I think it would have been a disproportionate burden on our senior citizens, most of whom are living on fixed incomes,” he said.

A Tangled Mess

If DOR tries to collect sales taxes from cable companies alone, it is cruising for a lawsuit, warns Ron Main, executive director of the Broadband Cable Association of Washington.

“If the DOR enforces their interpretations, as expressed in their excise tax advisories, and demands that cable companies collect sales tax on local residential telephone service, while leaving other similarly situated service provided by the incumbent carrier still exempt from the sales tax, then DOR may face a legal challenge brought by the affected cable companies,” he said. “The association would file amicus in all likelihood.  Given that they believe that they need legislation to take that course of action, as evidenced by the introduction of HB 2128, I will be surprised if they pursue that course of action, absent passage of that legislation.”

So the next move is up to DOR. And DOR’s Gowrylow says it’s really a job for the Legislature. You can count on this issue to come back. “It is up to the Legislature to decide what they want to do,” he said. “Do they want to extend [the exemption] to everybody, say anybody with a cell phone, regardless of whether it is business or residential use, or whether it is something that you can drive away with in your car, or whether it is tied to a wire in your house? It is up to them to decide.”

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