Internet Tax Freedom Act.

As part of the 1998 budget package, Congress passed the Internet Tax Freedom Act (ITFA), effective Oct. 1, 1998 and ending Oct. 20, 2001. The ITFA exempts Internet service providers (ISPs) from state and local sales (and similar) taxes. The most important part of the ITFA, however, may be the

commission set up to study taxation of electronic commerce. This commission could ultimately recommend that Congress grant states the power to tax remote sellers, both Web-based vendors and traditional mail-order companies. Should Congress grant such powers, these companies would lose a major competitive advantage that currently enables them to make tax-free sales. (For additional discussion of the ITFA, see the Tax Clinic, p. 26, this issue.)

ITFA Exemption for Internet Access Services

The ITFA exempts Internet access from state and local taxes. For this purpose, a tax includes any kind of charge other than a fee imposed due to a specific benefit or service. The exemption is only temporary, however, and contains many exceptions. The exemption applies to taxes that were not imposed and enforced prior to Oct. 1, 1998; ISPs cannot be subjected to any new taxes, but taxes already in force may still be imposed.

Taxes on Internet Access

As of Oct. 1, 1998, the income or franchise tax of each state was generally enforced on all taxpayers. Accordingly, ISPs will continue to be subject to these taxes in all states that impose them.

As of that date, a limited number of states and localities imposed and actually enforced taxes other than income taxes on Internet access. The most common tax imposed is the gross receipts tax (sales tax) levied by states. The ITFA provides rules for determining which states' non-income taxes may continue.

There are two tests to determine if a tax was imposed and actually enforced on Internet access. Under both tests the tax must be authorized by statute. This is an easy requirement; most statutes, especially those related to sales and use tax, are fairly broad. Assuming a tax is authorized by statute, under the first test, taxes will be considered imposed and enforced if an ISP had reasonable opportunity to know that such taxes would be imposed. This occurs when there is a rule or other public proclamation specifically stating that Internet access would be subject to tax. Few states meet this criteria; few have made specific rulings on such taxes.