The IRS made the statement in late October in a “coordinated issues paper,” or memo sent to IRS agents in the field about how to handle an issue that is coming up frequently in audits of telephone companies.

When Congress further deregulated the US telephone industry in 1996, it worried that the quality of service would decline in urban ghettos and farm communities that offer less opportunity for profit.  Therefore, it required by law that “all providers of telecommunications services should make an equivalent and non-discriminatory contribution to the preservation and advancement of universal service.” Congress also set up a fund.  Each telephone carrier must pay a percentage of its interstate end-user revenues into the fund.  The carriers collect the amounts as a “USF surcharge” on phone bills.  Disbursements are then made from the fund back to telephone carriers to help defray the cost of delivering mandated universal services.  There are similar universal service funds at the state level to which phone companies can submit claims for reimbursement for lost revenues.

The phone companies argue they should not have to pay income taxes on the amounts they receive from these funds.  Government subsidies often go untaxed — for example, where a local community reimburses a railroad for the cost of an overpass so that highway traffic will not be tied up by trains or a city reimburses an electric utility for the cost of burying power lines.

However, the IRS insists the subsidies in this case are income because the intention is to supplement the telephone company’s income.

The telephone companies may end up in court.  The IRS coordinated issues paper is UIL: 61.40-01.