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City Taxes On Utility Bills
 
June 2006 CA-505-2

The city tax rate on my bill appears higher than the rate approved by the city government. Why is that?

Many cities and towns in Washington impose a business and occupation tax on utilities doing business within its boundaries. These taxes are generally based on a percentage of revenues a utility collects from customers within the city or town. Local utility taxes levied in Washington are imposed directly on the utility, which is solely responsible for payment. Most natural gas, electric, and telephone utility companies in the state pass on these taxes to its customers. In addition to the actual tax rate, utilities also include a charge based on additional costs for billing and collection. This is why the bill shows the charge as the “effect” of city tax rather than, simply, city tax.

It appears the utility is asking me to pay a tax on a tax. Is it legal to impose a tax on a tax?

The “effect “of the city tax is not legally viewed as a tax on a tax. The city is taxing the utility company (business and occupation tax), not the individual customer. The amount shown on the bill as the "effect” of city tax is a tax on the company that the Washington Utilities and Transportation Commission (UTC) allows the utility to pass onto customers.

Under state law, including UTC orders, utilities may impose an additional service charge to cover the cost of administering local or city taxes, e.g., billing and collection. One reason for this practice is so the UTC and customers can accurately determine what part of the local rates are due to local taxes.

Customer bills also include a charge for federal excise taxes. The methods utilities use to calculate federal excise taxes are mandated by state and federal law.

What is the legal basis for allowing utilities to charge for the increased "effect” of a tax?

Since this charge is not a tax, but a part of a utility-service charge, it must be included in the tax base for federal excise tax purposes. Federal law requires that all charges included on the bill be included in the tax base.

For example, the Internal Revenue Service has held that where a state or local taxing authority imposes a tax on the telephone company, rather than the customer, the effect of this tax may be passed on to the customer. The telephone company must include the tax in the federal excise tax base. This is true even though the “effect” of the tax may be shown as a separate item on the bill. Further, section 4251 (a) of the Internal Revenue Code imposes the federal excise tax on communications services. The tax applies to both local and toll service. This section requires the excise tax be paid by the person paying for the service – the telephone customer. Section 4254(a)(1) of the Code further requires that the tax be based on the sum of all charges for services on the bill. A company may not deduct costs or expenses from the base amount.

Has the Washington State Supreme Court upheld this practice?

Yes. The UTC first approved the recovery of costs to collect local utility taxes in an order entered on October 9, 1947. (See Fifth Supplemental Order, Cause No. F.H. 7229). The Washington State Supreme Court upheld this decision. The court found that these taxes were imposed on the telephone company rather than the customer. (See State ex. Rel Seattle v. Department of Public Utilities, 33 Wn.2d 896, 207 P.2d 712 (1949)).

Have the federal courts addressed this issue?

Yes. Since these local taxes are imposed on the company rather than the customer, they represent costs of doing business. The “effect” of these costs is passed on as an additional service charge for the company's services. Under Internal Revenue Code Section 4251, the company is required to calculate the federal excise tax by including all charges as part of the federal tax base. Federal courts have upheld this requirement when addressing state and local taxes. See Rev. Rul. 77 -472, 1977·2 CB 379; Rev. Rul. 73-184, 1973-1 CB 455; and Rev. Rul. 69-151, 1969-1 CB 288; see also State of Minnesota et. al. v. U.S., 75-2 USTC ¶ 16,204, 525 F.2d 231 (8th Cir. 1975); Agron v. Illinois Bell Telephone Co., 71-2 USTC ¶ 16,014, 449 F.2d 906 (7th Cir. 1971).