Extended Yet Again: The Debate Over State Taxation of Internet Access Will Be One for the 114th Congress

By Sarah McGahan, J.D., LL.M., and Troy Young, J.D., LL.M.

At the end of the 113th Congress, lawmakers kicked the proverbial can down the road when they left the issue of taxing internet access to the 114th Congress. Doing things on a temporary or stopgap basis was not unique to the 113th Congress: Congress has batted the issue of taxation of internet access about for almost two decades. Will 2015 be the year something changes?


As originally enacted in 1998, the Internet Tax Freedom Act (ITFA) 1 prohibited states and local governments during the following three-year period from imposing (1) any new taxes on charges for internet access, or (2) any multiple or discriminatory taxes on electronic commerce. States and localities that had generally imposed and actually enforced taxes on internet access before ITFA's effective date of Oct. 1, 1998, were allowed to continue taxing under the so-called grandfather provisions. In the original act, "Internet access service" was defined as:

a service that enables users to access content, information, electronic mail, or other services offered over the Internet and may also include access to proprietary content, information, and other services as part of a package of services offered to consumers. Such term does not include telecommunications services. 2

The impetus behind ITFA in 1998 was simple: The world was entering the digital age—the age of information—and the internet was going to become a critically important tool. Because the internet was in its infancy, it was widely believed that burdensome taxation would likely impede its growth. In fact, then-Rep. Chris Cox, R-Calif., a co-sponsor of the original act, stated that "the Internet Tax Freedom Act is based on a simple principle: Information should not be taxed." 3

For reasons largely unrelated to ITFA, internet use grew exponentially in the years after 1998. In 2000, according to the U.S. Census Bureau, 42% of households reported at least one member who used the internet at home. 4 In contrast, 26% of households used the internet in 1998 and only 18% in 1997. 5 By 2013, the U.S. Census Bureau said that 74.4% of households reported using the internet at home. 6

After the original ITFA expired on Nov. 1, 2001, the Internet Tax Nondiscrimination Act of 2001 7 was signed into law on Nov. 28, 2001. This bill extended the moratorium to Nov. 1, 2003. No changes were made to the act's substantive provisions.

On Dec. 3, 2004, another Internet Tax Nondiscrimination Act 8 was enacted, extending the provisions to Nov. 1, 2007. The extension was retroactive for a one-year period to November 2003. With this extension, Congress made substantive changes to the moratorium's provisions. Notably, the act was revised to provide that the term "Internet access" does not include telecommunications services "except to the extent such services are purchased, used, or sold by a provider of Internet access to provide Internet access." 9 Some thought that this expanded definition of internet access captured the type of services provided by telecommunications, cable, and other internet "backbone" service providers to internet service providers (ISPs) and their customers.

The 2004 Internet Tax Nondiscrimination Act also specifically created an exception to the general prohibition for taxes imposed on charges for voice or similar services using internet protocol (e.g., voice over IP, or VoIP). Also, the 2004 legislation revised the grandfather provisions and mandated that the U.S. comptroller general study the impact of the moratorium on state and local government revenues and on the deployment and adoption of broadband technologies for internet access throughout the United States and report the findings to specified congressional committees. The 2004 extension was set to expire on Nov. 1, 2007.

From the time the 2004 Internet Tax Nondiscrimination Act was signed through 2007, there was much debate over whether the moratorium should be extended temporarily, be made permanent, or be allowed to sunset so that states and localities could impose taxes on internet access. In addition, much debate centered on whether the grandfathered states should continue to enjoy preferential status.

After months of hearings and debates, on Oct. 31, 2007, President George W. Bush signed the Internet Tax Freedom Act Amendments Act of 2007. 10 This legislation extended the moratorium to Nov. 1, 2014, and made numerous substantive changes to the law. Notably, the 2007 Act:

  • Amended the definition of internet access;
  • Provided a phaseout of certain grandfathered taxes on telecommunications services;
  • Adopted a "use it or lose it" provision that prohibited certain grandfathered states from imposing taxes on internet access if they had not been doing so; and
  • Specifically provided that certain state gross-receipts taxes were not to be considered prohibited taxes on internet access.

Definition of internet access: The key changes to the definition of internet access were that services incidental to the provision of internet access services, such as a homepage and email, were now included, regardless of whether these services were provided separately or were bundled with internet access. Additionally, although the act previously included a provision excepting services such as VoIP from the moratorium, the ITFA of 2007 went further and specifically excluded voice, audio, or video services using internet protocol from the definition of internet access. This ostensibly would allow states to continue to tax services such as internet protocol television (IPTV) that were at the time replacing many traditional taxable services.

Amended grandfather provisions: The 2007 ITFA retained the grandfather provisions, thus allowing state and local governments to continue taxing internet access if the tax was generally imposed and actually enforced prior to Oct. 1, 1998. However, the bill contained an exception to the grandfather provisions that affected certain states that imposed and enforced a tax on telecommunications services purchased, sold, or used by a provider of internet access prior to November 2003. The states that previously had been granted permission to tax these telecommunications were allowed to continue doing so only until June 30, 2008. Arguably, this period was to allow states time to adjust their budgets for any revenue loss resulting from the change in the law.

Use it or lose it: Under the revised 2007 ITFA, grandfathered states that, more than 24 months prior to Oct. 31, 2007, had either (1) repealed their taxes on internet access, or (2) issued a rule or other proclamation by an appropriate state agency stating internet access was not taxable, would no longer be covered by the grandfather provisions. Therefore, any such state that had not been exercising its privilege to tax internet access under the grandfather provisions was prohibited from taxing internet access in the future.

Specific taxes excluded: One concern raised during the 2007 debates over whether to extend the moratorium was how it affected states that had adopted gross-receipts taxes. In other words, would these general business taxes imposed on internet access providers be construed as an indirect tax on internet access? Although ITFA specified that a "tax on Internet access" did not include a tax levied upon or measured by net income, capital stock, or property value, it did not specifically address the hybrid gross-receipts taxes a number of states had adopted or considered. Under the 2007 ITFA, specifically excluded from the definition of taxes on internet access were the Washington state business and occupancy (B&O) tax, the (now-defunct) Michigan gross receipts tax, the Ohio commercial activity tax, and the Texas franchise tax. However, it is important to note that the revised bill excluded only such taxes enacted before Nov. 1, 2007. Thus, the law would not protect states enacting some type of gross-receipts tax after Nov. 1, 2007.

2014 Activity

As the 2014 sunset date approached, once again there was much speculation in the state tax community over whether and how Congress would extend the moratorium. Given the number of times the moratorium had been extended, certain members of Congress (and many in the tax and business communities) supported permanently prohibiting state and local governments from taxing internet access and imposing multiple or discriminatory taxes on e-commerce. To accomplish this, Rep. Bob Goodlatte, R-Va., introduced the Permanent Internet Tax Freedom Act, H.R. 3086, on Sept. 12, 2013. Likewise, on Aug. 1, 2013, Sen. Ron Wyden, D-Ore., introduced the Internet Tax Freedom Forever Act, S. 1431, which similarly sought to make permanent the ban on imposing sales and use taxes on internet access. Furthermore, the House and Senate bills would have eliminated the grandfather provisions by allowing them to expire. Both the House and Senate permanent moratorium bills received bipartisan support with 228 and 52 co-sponsors, respectively. H.R. 3086 passed the House on July 15, 2014, but failed to advance in the Senate. S. 1431 did not make it out of committee.

Another state and local tax bill that the 113th Congress considered at the same time was the Marketplace Fairness Act of 2013 (MFA). Had Congress passed it, the MFA would have allowed states, under certain conditions, to require certain remote sellers to collect and remit sales and use taxes with respect to "remote sales" even if the seller lacked a physical presence in the state. In essence, the MFA would have allowed states to collect sales tax revenue from online retailers outside their borders. A version of the MFA (S. 743) passed the Senate on May 6, 2013, but it failed to garner support in the House. Throughout much of the 113th Congress, there was considerable discussion of joining the MFA with ITFA to generate additional support for the MFA. This culminated with the introduction of the Marketplace and Internet Tax Fairness Act, S. 2609, on July 15, 2014, which combined the MFA with a 10-year extension of ITFA.

As ITFA's expiration date approached with no apparent resolution in Washington, a number of states began issuing guidance addressing the state tax consequences if ITFA were to sunset. Notably, a number of states issued guidance stating that under their current law, internet access would remain exempt from tax absent specific authorizing legislation. For instance, the Nebraska Department of Revenue issued a general information letter stating that Nebraska did not impose sales and use tax on charges for internet access as currently defined under federal law, and, therefore, expiration of the act would not affect the taxability of internet access services. 11 The Michigan Department of Treasury likewise stated that the state did not currently tax services directly enabling users to connect to the internet, and, therefore, ITFA's expiration would not change that status. 12

The Alabama Department of Revenue issued a news release advising internet access service providers to continue to treat internet access charges as exempt until further notice. The department assured taxpayers that any change in taxability would be prospective only, and only after a 60-day notice period. 13 The apparent exception to the general rule that the expiration of ITFA would not immediately result in the imposition of tax on internet access charges was Washington state. The Washington Department of Revenue reportedly noted in an informal survey that internet access services would be subject to retail sales and use tax upon the expiration of ITFA. 14

The 113th Congress, which has been called the "least productive" in recent history, 15 failed to pass legislation dealing with ITFA on a permanent or long-term basis. As the clock wound down toward the Nov. 1, 2014, expiration, Congress did move to provide a short-term extension. The Continuing Appropriations Resolution, 2015, 16 signed by President Barack Obama on Sept. 19, 2014, was enacted to keep the government funded through Dec. 11, 2014. As a temporary solution to prevent ITFA's expiration on Nov. 1, 2014, the government funding bill included provisions extending ITFA through Dec. 11, 2014.

Some in the state tax community believed that Congress might seriously deal with the ITFA moratorium, as well as other issues affecting state taxation (e.g., the Marketplace Fairness Act), during the lame-duck session following the November midterm election. However, as the Dec. 11 expiration date approached, it appeared increasingly unlikely that Congress would act on a permanent version of ITFA or the combined ITFA/MFA Senate bill (S. 2609). Any hope that S. 2609 would be enacted during the lame-duck session was dashed when House Speaker Rep. John Boehner, R-Ohio, vowed to block any measure giving states broader power to tax online sales. 17

On Dec. 16, 2014, Obama signed the more than 1,600-page Consolidated and Further Continuing Appropriations Act, 2015. 18 It contained a provision extending ITFA's expiration date to Oct. 1, 2015. No substantive changes to ITFA were included in the appropriations act. As a result of this short extension, the 114th Congress will have the opportunity to consider the substantive provisions and the expiration of ITFA in less than a year.

Next Steps

Although Congress has given itself a reprieve from addressing the issues associated with the moratorium, it is likely that there will be much debate as the Oct. 1, 2015, sunset approaches. Notably, there will likely be discussions over whether to make the moratorium permanent or to simply extend it again. There is also the question of what to do with the seven grandfather states—Hawaii, New Mexico, North Dakota, Ohio, South Dakota, Texas, and Wisconsin—that continue to impose taxes on internet access under the grandfather provisions. These states would face a loss of revenue if the grandfather provisions were eliminated, as was proposed in the permanent ITFA bills introduced in 2013.

Some believe that Congress should allow the moratorium to sunset. Organizations that oppose a permanent moratorium generally argue that ITFA was never intended to be permanent. 19 Furthermore, they contend that the reasons for enacting the moratorium in 1998 are no longer relevant, as internet use in 2015 is so widespread and established that it is hard to argue that taxing access to the internet will quell its use or slow broadband deployment. 20

The coming ITFA debate may also place more emphasis on the revenue states could collect if the ban is ended, which has been estimated (assuming that all states imposed sales and use tax on internet access) at $6.5 billion per year. 21 Although the amount of tax revenue that states do not collect as a result of the moratorium is debatable, it is clearly a significant sum. According to opponents, given the fiscal plight of the states, with rising Medicare and pension costs, as well as the states' desire to increase and improve services and attract investment through incentives, it is questionable whether a federal bill exempting internet access from sales taxes is proper.

Finally, as technology evolves, the fine line between taxable telecommunications and nontaxable internet access becomes blurred. As such, opponents of a permanent moratorium argue that it does not simply prohibit states from taxing internet access services that they never before taxed but effectively prohibits taxation of traditionally taxable services that providers now deliver online.

By contrast, proponents of an additional extension or a permanent moratorium generally argue that allowing states to impose tax on internet access would hurt the growth of the wireless industry and price out lower-income customers. 22 Pointing to the regressive nature of sales taxes and the traditionally hefty taxes imposed on traditional telecom services, proponents argue that the steep taxes would impose an unnecessary burden on consumers and providers.

Furthermore, proponents cite studies indicating that taxing internet access could cause a loss of subscribers. According to a study by economist George Ford of the Phoenix Center, 23 even a relatively low sales tax rate of 2.5% could reduce broadband subscribership by 5 million to 15 million, compared with what it would otherwise be. If state sales taxes averaged 5%, the loss could total 10 million to 30 million subscribers.

It remains to be seen what will happen. Already in 2015, a new Permanent Internet Tax Freedom Act identical to the 2013 version has been introduced in the House. 24 The only thing certain is that today, tomorrow, and 10 years down the road, the internet will be a part of people's lives.

This article represents the views of the authors only and does not necessarily represent the views or professional advice of KPMG LLP. The information contained herein is of a general nature and based on authorities that are subject to change. Applicability of the information to specific situations should be determined through consultation with a company's tax adviser.


1 Internet Tax Freedom Act, Title XI, P.L. 105-277.

2 Id., §1101(e)(3)(D).

3 H.R. Rep't 105-570, 105th Cong., 2d Sess. (June 5, 1998).

4 U.S. Census Bureau, P23-207, Home Computers and Internet Use in the United States: August 2000 (2001).

5 Id.

6 U.S. Census Bureau, ACS-28, Computer and Internet Use in the United States: 2013 (2014). This is the most recent U.S. Census Bureau report available.

7 Internet Tax Nondiscrimination Act, P.L. 107-75.

8 Internet Tax Nondiscrimination Act, P.L. 108-435.

9 Id., §2(c)(2).

10 Internet Tax Freedom Act Amendments Act of 2007, P.L. 110-108.

11 Nebraska Dep't of Rev., General Information Letter 1-14-2 (Aug. 22, 2014).

12 Michigan Dep't of Treasury, Sales and Use Tax Information (Sept. 18, 2014).

13 Alabama Dep't of Rev. news release, "Internet Tax Freedom Act Scheduled to Expire in December" (Oct. 10, 2014).

14 As noted above, internet access is subject to Washington's B&O tax, and Washington has adopted the definition of internet access under ITFA with some modification. See Wash. Rev. Code §82.04.297.

15 Bump, "The 113th Congress Is Historically Good at Not Passing Bills," The Washington Post (July 9, 2014).

16 Continuing Appropriations Resolution, 2015, P.L. 113-164.

17 Becker, "Boehner Vows to Block Online Sales Tax Bill," The Hill (Nov. 10, 2014).

18 Consolidated and Further Continuing Appropriations Act, 2015, P.L. 113-235.

19 Letter from National Association of Counties to U.S. representatives (July 7, 2014). National League of Cities, U.S. Conference of Mayors, International City/County Management Association, Government Finance Officers Association, and National Association of Telecommunications Officers and Advisors joined the letter.

20 Letter from AFL-CIO to U.S. representatives (July 11, 2014). Numerous other labor unions, including Service Employees International Union, joined the letter.

21 Mazerov, "Congress Should End—Not Extend—the Ban on State and Local Taxation of Internet Access Subscriptions," Center on Budget and Policy Priorities (July 10, 2014).

22 Tayloe, "Moratorium on Internet Access Tax Should Become Permanent, Say CTIA, Coalition," The Institute for Policy Innovation (Oct. 23, 2013).

23 Gattuso, "Read My Bits: No New Taxes (Permanently)," The Heritage Foundation (June 30, 2014).

24 H.R. 235, 114th Cong. (2015).



Sarah McGahan is a senior manager and Troy Young is a senior associate, both with the state and local tax group of KPMG LLP’s Washington National Tax practice. For more information about this column, contact Ms. McGahan at smcgahan@kpmg.com.


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