Temporary moratorium in place since 1998 now permanent.

Capitol-1For nearly 20 years most of you have been free from state and local taxes on your Internet access – and also from multiple or discriminatory state/local taxes on e-commerce. You’ve got Congress to thank for that. You may not have realized, however, that that freedom has been at most temporary, initially set to expire in 2001 but extended several times since.

Until now.

On February 24, President Obama signed into law the Trade Facilitation and Trade Enforcement Act (Public Law No. 114-125), which includes language making permanent limitations first imposed in 1998 on state and local taxation of certain Internet-related activities. Specifically, the new law removes the sunsetting provision to which those limitations had been subject and it provides that some such state taxes, previously grandfathered, will themselves sunset no later than June 30, 2020. (States with such taxes reportedly include Hawaii, New Mexico, North Dakota, Ohio, South Dakota, Texas and Wisconsin.)

In other words, Congress has permanently barred states and localities from imposing (a) taxes on your Internet access and (b) multiple or discriminatory taxes on e-commerce.

The expansion of the World Wide Web in the 1990s brought an ever-increasing number of people and businesses online. The bad news: Many opportunistic state and local taxing jurisdictions were quick to recognize the revenue potential presented by the phenomenon of the Internet. The good news: Congress, having recently passed the Telecommunications Act of 1996 encouraging Internet development, was concerned that new taxes on Internet activity would inhibit that development. As a result, included in the massive Omnibus Consolidated Appropriations Act passed in October, 1998, was a section (Title XI, if you’re looking) entitled the Internet Tax Freedom Act (ITFA). It established a three-year moratorium on state and local “[t]axes on Internet access” and “[m]ultiple or discriminatory taxes on electronic commerce.”

What exactly did this ban reach?

First, taxes on “Internet access,” which was clunkily defined as “a service that enables users to connect to the Internet …” including “the purchase, use or sale of telecommunications … to the extent such telecommunications are purchased, used or sold … to provide [a] service” that “enable[s] users to access content, information or other services offered over the Internet.” Such services include not only the full range of access arrangements (e.g., dial-up, private line, DSL, and other broadband technologies), but also incidental features (e.g., browsers, home pages, and email) typically bundled with access offerings. (They do not include, however, voice, audio or video programming.)

And as for “discriminatory” and “multiple” taxes? The IFTA banned state/local taxes on e-commerce (a) that are greater than or not correspondingly imposed on comparable non-online transactions (i.e., “discriminatory” taxes) and (b) for which a similar tax is imposed by another jurisdiction without offsetting credits (i.e., “multiple” taxes). Notably, the ITFA does not otherwise exempt from taxation the online sales of goods, so long as any such taxes do not run afoul of these prohibitions.

Originally set to sunset in 2001, the 1998 moratorium has been extended a number of times, with some clarifications and modifications. Also adopted in 1998 and continued in effect since then was a grandfathering provision that allowed 13 states that already had such taxes in place before the IFTA moratorium to continue to impose those taxes. (That number has now dwindled to the seven states identified above.)

The Debate
Despite enjoying widespread support, the ITFA has been controversial from the get-go.

Proponents argue that taxation-increased costs should not be allowed to undercut the myriad benefits (commercial, educational, etc.) of the Internet. Moreover, the costs of such state/local taxation could discourage low-income individuals from using the Internet, thereby exacerbating the so-called Digital Divide. And what about the adverse impact on Internet service providers who would have to bear the costs and administrative burdens of complying with taxes imposed by the thousands of state and local tax jurisdictions?

Opponents counter that the tax exemption deprives states and localities of necessary revenues and unfairly discriminates against services not delivered via the Internet. As for low-income users, carefully tailored subsidies could be targeted more directly to such folks.

Most controversially, although not directly addressed by the ITFA itself, a number of interest groups complain that any action on Internet taxation should include a resolution of the debate over taxation of online purchases. There is currently a patchwork of such taxes in effect in some, but far from all, jurisdictions. The ability of a state or locality to tax an online vendor depends on whether or not the vendor has sufficient connections with the given jurisdiction to render its products taxable there and, as a practical matter, whether the vendor has established mechanisms to collect any taxes owed. “Brick-and-mortar” businesses competing with online retailers see themselves at a substantial disadvantage because of this differing tax treatment.

In the end, the proponents prevailed: the once-temporary 1998 moratorium is now permanent, and the handful of remaining states whose pre-ITFA taxes had been grandfathered in 1998 will be required to eliminate those taxes before July, 2020.

The decision to make the ITFA moratorium permanent does not resolve the issue of state/local taxation of online purchases, however. Instead, proponents of the Marketplace Fairness Act (MFA) currently pending in the Senate – a bill that would address that issue head on – merely obtained a promise that the MFA would be considered in this Congressional session.

What Happens Now?
The legislation brings helpful stability to the pricing of Internet access offerings generally. As House Judiciary Committee Chairman Bob Goodlatte (R-VA) said, the new law

is about giving every American unfettered access to the Internet, which is the modern gateway to the American dream. Internet access drives innovation and, increasingly, the success of our economy. A permanent ban on Internet access taxes will help prevent unreasonable cost increases that hurt consumers and slow job creation, innovation and the spread of knowledge.

For its part, the MFA will likely get its promised consideration later in this Congress, but many are skeptical about its chances for passage. Accordingly, states reportedly are already gearing up to find alternative means to impose taxes on Internet transactions by cutting deals with companies regarding sales of goods purchased from out-of-state online vendors, redefining sales and use taxes, including third party delivery services in the definition of “physical presence” for taxation purposes, and the like.

The FCC has also addressed the Internet taxation issue. In its “Net Neutrality” decision (at paragraphs 430-433, if you’re interested), the Commission provided that the reclassification of Internet broadband services as “telecommunications services” would not remove those offerings from the moratorium protection of the ITFA. It remains to be seen if that conclusion as well will face challenges from states and localities, which already impose substantial taxes on other telecommunications offerings.