Just when T-Mobile (NASDAQ:TMUS) and Sprint (NYSE:S) were feeling good about their proposed $26 billion megamerger -- the companies scored approval from the Department of Justice antitrust division two months ago -- a bombshell allegation from the Federal Communications Commission (FCC) threatens to derail the deal. The FCC had been poised to approve the merger after appearing to secure a third vote of support in May, but a multistate lawsuit filed by a slew of state attorneys general (Pennsylvania joined a few days ago) is still pending.

The FCC is now accusing the No. 4 U.S. carrier of improperly collecting subsidies related to its Lifeline program.

John Legere and Marcelo Claure sitting next to each other laughing

Image source: T-Mobile.

Collecting on nearly 900,000 unused lines

The agency announced today that Sprint had received millions of dollars in taxpayer-funded subsidies for 885,000 Lifeline subscribers that were not using the service, neither voice minutes or data. That represents approximately 30% of Sprint's Lifeline subscriber base and almost 10% of the program's total subscriber base. The FCC says that Sprint reaped tens of millions of dollars in improper subsidies.

Lifeline is a federal program designed to help subsidize wireless service for low-income Americans, offering at least $9.25 per month per household in subsidies to qualifying subscribers. The subsidies are paid directly to the wireless carrier, which is then required to extend a discount to the qualifying subscribers. Regulators allege that Sprint was violating the "non-usage" rule that is intended to prevent waste, fraud, and abuse of the program.

Lifeline providers are supposed to de-enroll inactive subscribers that haven't used their mobile phones in 30 days. The subsidies bring the cost of wireless service down to free for most of Sprint's Lifeline subscribers, which essentially puts the onus on carriers -- popular dividend stocks -- to recognize when the subscriber ceases using the service. Since the subscriber will oftentimes fail to take action in canceling service because they aren't paying anything anyway, the result is a glut of unused lines that taxpayers are on the hook for.

Commissioner backlash

"It's outrageous that a company would claim millions of taxpayer dollars for doing nothing," FCC Chairman Ajit Pai said in a statement. "This shows a careless disregard for program rules and American taxpayers." Pai added that he was asking the agency's Enforcement Bureau to investigate the allegations.

FCC Commissioner Geoffrey Starks, one of two Democrats on the commission, went as far as to call for the merger to be paused so that the investigation can play out.

Lifeline is part of Sprint's prepaid and wholesale businesses. For example, the Virgin Mobile brand is "designated as a Lifeline-only Eligible Telecommunications Carrier," the company notes in regulatory filings. Some mobile virtual network operators (MVNOs) that buy wholesale capacity from Sprint also sell prepaid service as part of the Lifeline program.

The prepaid brands play an important role in the merger: T-Mobile and Sprint have agreed to divest prepaid assets as part of a package of concessions to regulators, since T-Mobile already dominates that segment of the market.