Fifth Circuit Rules USF Contributions Income

TEXAS – Companies receiving state and federal Universal Service Funds (USF) must pay federal income tax on those funds, according to a judgment from the Fifth Circuit earlier this month.

The appellate court upheld a summary dismissal from the U.S. District Court for the Western District of Texas against AT&T on a claim for the refund of more than $500M in income taxes paid to the Internal Revenue Service. The carrier maintained that more than $1.5B in state and federal USF contributions received between 1998 and 1999 should not be subject to federal income tax.

AT&T argued that contributions from the USF, which subsidizes affordable telephone service, should be considered non-shareholder contributions to capital rather than gross income.  Gross income is subject to regular income tax rates while non-shareholder contributions are not.  In rejecting AT&T’s claim, the court looked to the Government’s intent to supplement “lost revenues” the carrier incurred by providing service to high-cost and low-income subscribers.