Internet Tax Freedom Act

views updated


The U.S. Congress addressed the controversial issue of taxation and e-commerce with the passage of the Internet Tax Freedom Act (ITFA), which took effect in October 1998. ITFA prohibited the imposition of new e-commerce taxation from October 1, 1998 to October 21, 2001. According to the legislation's sponsors, ITFA was enacted to create a tax-free period that would allow for the unfettered growth of Internet commerce during its formative stages. At the same time, a clear and efficient national e-commerce tax policy could be developed.

Interest in the burgeoning world of e-commerce boomed as the financial stakes involved became more apparent. Some estimates projected that e-commere transactions will top $300 billion by 2002, representing a huge potential source of sales, and possibly tax, revenues. As of 2001, 45 states and the District of Columbia levied sales taxes on commercial transactions that occurred within their borders. They also imposed use taxes on goods and services that customers bought out-of-state but consumed in their home state. Under the Commerce and Due Process Clauses, states or localities traditionally could only claim tax jurisdiction if they could demonstrate that a "substantial nexus" existed between vendor and purchaser, which generally was understood to mean that the seller had a physical presence, such as a store or warehouse, in the state in which the item was purchased. Part of the dilemma concerning the taxing of e-commerce transactions is that in many cases such a substantial nexus does not exist, because an online customer can buy items over the Internet regardless of where he or she and the seller are physically located.

The question was further complicated by the fact that sales taxes can be more easily applied to transactions involving the transfer of tangible goods. However, many of the items sold online are intangible, such as downloaded songs, information services, and other goods that traditionally have been exempt from sales taxes. Finally, the United States contains more than 30,000 independent state and local tax jurisdictions. Thus, the duty of the seller to collect and remit sales and use taxes is vastly more challenging if they must be able to calculate the appropriate tax rates for each jurisdiction, rather than only that of the state and locality in which they are located.

Among ITFA's major provisions was a three-year moratorium placed on several types of e-commerce taxes. First, it prohibited the taxation of Internet service providers (ISPs) such as AOL; states could not require that ISPs charge state taxes in addition to their monthly service fees. However, ITFA did incorporate a grandfather clause that permitted the continuation of any taxes that had been "generally imposed and actually enforced prior to October 1,1998." Such taxes existed in the District of Columbia and eleven states.

ITFA instituted another three-year ban on any new state or local taxes considered to be "multiple and discriminatory"that is, those that would subject buyers to e-sales taxation in more than one state. This provision followed the taxation guidelines set down for interstate mail-order sales by the U.S. Supreme Court's 1992 decision in Quill Corp. v. North Dakota, in which the court ruled that the Commerce Clause exempted mail order houses from a duty to collect sales taxes unless they possessed a "substantial nexus" (understood to be a physical presence) with the taxing jurisdiction. ITFA also shielded from taxation all goods and services sold exclusively online for the duration of the moratorium.

Under ITFA, for a state or locality to tax e-commerce transactions, the conditions surrounding the imposition of the tax and the taxation rate must match those that pertain to traditional, "bricks-and-mortar" sales transactions. In such cases, the e-tailer would be responsible for collecting and remitting the amount of that tax, just like traditional commercial retailers.

Finally, ITFA urged the president to collaborate with the European Union and the World Trade Organization to guarantee that all e-commerce continued to be exempt from tariffs and other international taxes. In addition, ITFA established a national Advisory Commission on Electronic Commerce to study the issues surrounding e-commerce taxation and to submit a final report of its findings and recommendations to Congress by April 2001. The commission's 19 membersfederal, state, and local governmental officials, as well as representatives from taxpayer and business groupsrepresented all viewpoints in the e-commerce taxation debate.

However, the commission did not submit a comprehensive final report for Congress by the scheduled deadline, since it failed to gather the two-thirds majority necessary to issue an official statement. Instead, the situation remained unresolved, with the commission agreeing to extend the moratorium on Internet taxes until 2006 and to conduct further discussions. Among its "non-official" recommendations, the commission advocated the repeal of the three-percent federal excise tax on telecommunications services, the permanent banning of state and local taxation on Internet access fees, the simplification of state sales and use taxes, and a ban on all international tariffs on e-commerce transactions.


Cox, Christopher. "Internet Tax Freedom at One: No Net Taxes, More Sales Tax Revenue." Washington, D.C.: Office of U.S. Representative Christopher Cox, 1998. Available from

. "'Plain English' Summary of the Internet Tax Freedom Act (P.L. 105-277)." Washington, D.C.: Office of U.S. Representative Christopher Cox, 1998. Available from

Fallaw, Timothy. "The Internet Tax Freedom Act: Necessary Protection or Deferral of the Problem?" Journal of Intellectual Property Law. Fall 1999.

Huddleson, Joe. "Internet Taxation Issues Remain Unanswered." The Tax Adviser. February 2001.

McLaughlin, Matthew. "The Internet Tax Freedom Act: Congress Takes a Byte Out Of the Net." Catholic University Law Review. Fall 1998.

SEE ALSO: Digital Divide; Taxation and the Internet

About this article

Internet Tax Freedom Act

Updated About content Print Article