The Internet Tax Freedom Act

The explosive growth of the Internet during the 1990s often upended old rules or assumptions about business, technology and law. The issue of taxation was no exception – businessmen, legislators and consumers found themselves facing questions that current tax law had no answers for. Business owners who wanted to expand online wondered if they would have to collect and remit state and local sales taxes for each of the hundreds of jurisdictions in which they sold goods. Politicians worried that state and local governments would impose punitive taxes on Internet services that could hamper the growth and accessibility of the Internet.

These were the sorts of concerns that prompted Congress to pass the Internet Tax Freedom Act (ITFA) of 1998. The Act instituted a three year tax moratorium, which had several effects. First, the Act prohibited state and local governments from taxing Internet access. were As part of a political compromise, Internet access taxes were grandfathered in for twelve states (including Ohio) which already had laws of this sort. The ITFA also prohibits “multiple or discriminatory” taxes on e-commerce. Although this language is intentionally broad, this provision is generally intended to prevent states and localities from taxing Internet-based transactions differently or at different rates from their non-Internet equivalents.

The Act also relieves some of the burden on e-retailers to collect sales taxes for sales to customers in other states. Although (contrary to popular perception) the ITFA does not prohibit all sales taxes on Internet purchases, it generally supports the rule that a business must only pay sales taxes in states in which it has an actual physical presence. This follows the result of the Supreme Court’s decision in Quill corp. v. North Dakota, which had originally given a similar tax exemption to other types of “remote sellers,” such as mail-order businesses. Courts have generally held that the presence of employees or facilities is necessary to establish an entity’s tax presence in a particular state. In other words, e-businesses needn’t file state and local tax returns in every jurisdiction in which their websites are accessed.

The ITFA is still in effect, having been renewed in 2001, 2004 and most recently in 2007. The Act has been broadly popular, and many groups are pushing to make it permanent. Yet many of the issues underlying the Act remain frustratingly complex, especially that of sales tax for remote retailers. State and local governments have complained about lost revenue from untaxable e-commerce transactions, but little change is likely to occur in this area in the near future. The tax moratorium established by the ITFA is currently scheduled to expire in 2014.