After much discussion and heated debate involving members of Congress, industry, and state and local government officials, the Federal Internet Tax Freedom Act (F-ITFA) was enacted in October 1998.
The Basics
The F-ITFA imposes a 3-year moratorium (from October 1, 1998 through October 21, 2001) on state and local taxes on Internet access, unless such tax was generally imposed and actually enforced before 10/1/98 (about ten states had such taxes in place, but not California). The moratorium also applies to multiple or discriminatory taxes on e-commerce. There are limited exceptions to the moratorium for certain taxpayers who use the Web to send materials that are harmful to minors, and Internet access providers who don't offer screening software to limit materials harmful to minors.
The F-ITFA also calls for creation of a 19-member Advisory Commission on Electronic Commerce. The members include the Commerce and Treasury secretaries, the U.S. Trade Representative, eight people representing state and local governments (including one from a state with no sales tax, and one from a state with no income tax), and eight from e-commerce industries (including one small business representative). This group is to conduct a thorough study of all levels of tax with respect to e-commerce, including considerations of all types of remote commerce (including mail order). The Commission ends and their report is due to Congress on April 21, 2000.
The F-ITFA also includes sense-of-congress declarations that the Internet should be free of foreign tariffs, trade barriers, and other restrictions, and that no new federal taxes should be imposed during the moratorium.
The rationale behind the F-ITFA is to allow time for study and reflection during the infancy of e-commerce to help ensure fair and workable rules that won't impede growth of the Internet. Reasons against the F-ITFA included federalism concerns of the federal government restricting state and local action, and singling out one type of commerce for special treatment.
The Myths
Despite the "tax freedom" reference in its title, various taxes are still imposed on transactions involving use of the Internet. The F-ITFA specifically preserves state and local taxing authority that is otherwise permissible. Thus, a California resident purchasing taxable goods over the Internet from a vendor not subject to use tax collection obligations, is still liable for use tax on the goods.
The Realities
Some sponsors of the F-ITFA view it as a temporary ban and expect the Commission to recommend a permanent ban (S. 328 introduced in January 1999 calls for a permanent moratorium). Given that very few states impose taxes on Internet access, the effect of a permanent moratorium on such taxes does not appear to be significant. However, discussion on the meaning of multiple and discriminatory taxes is significant given the difficulty of applying certain tax rules to Internet transactions, such as where and how transactions should be taxed. For example, where should any sales tax be paid for candy ordered via the Internet from an Ohio vendor by a California resident while traveling in Georgia that is sent to a relative in Michigan? And, who should collect the tax? Simple and uniform rules to avoid taxation of this purchase in more than one state would be helpful. Also, clarification of whether or not use of an Internet access provider creates nexus for a remote vendor would be helpful (the F-ITFA includes this as a discriminatory tax).
Arguably, the presence of over 6,000 jurisdictions in the U.S. capable of assessing sales tax calls for simplification and clarification of when these taxes can be assessed so that small businesses do not shy away from the market potential of the Internet due to tax compliance concerns. Hopefully, the work of the Commission will help in bringing some simplification and clarification to subnational tax rules for the benefit of consumers, vendors, and state and local governments. Unfortunately, the Commission has only an 18-month time frame to conduct its thorough study of subnational, federal, and international Internet-related tax issues. In addition, due to lack of a mechanism to ensure that it would have the balanced number of government and industry members, the Commission ended up with nine industry reps and only seven from government - a problem that may delay work of the commission, cutting into its already short existence.
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Last Modified: Feb 22, 2023