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The Last Bastion of Freedom from State Taxes: Your Internet Connection

There is one service free from state and local taxes that few people even know about because it is not a significant line-item on their internet bill. That is the taxation of internet access. In November, President Obama signed H.R. 719, the Continuing Appropriations Act, 2016. Buried in this legislation is an extension of the Internet Tax Freedom Act, which has been extended multiple times by Congress, usually at the last minute before it expired and usually for only a short period of time. The latest extension expires on December 11, 2015.

So what is this perpetually extended law all about? The Internet
Tax Freedom Act is a temporary moratorium preventing state and local governments from taxing Internet access or placing “discriminatory” taxes on e-commerce. Digital subscriber lines and Voice over Internet Protocol services are included in the tax ban. This law is not about making businesses collect sales taxes on internet sales, although it does limit state tax jurisdiction based on the location of remote computer servers. Rather, it is about state and local governments taxing internet access.

Seven States Grandfathered In

Currently, seven states tax Internet access because they were grandfathered in at the time the original Internet Tax Freedom law was passed. They include: Hawaii, New Mexico, North Dakota, Ohio, South Dakota, Texas, and Wisconsin.  According to the Congressional Research Service (CRS), these seven states collect a combined $563 million per year from taxes on Internet access.

No Win Situation for Congress

The law was first enacted in 1998, and Congress struggles each year to extend it. Consumers and businesses want Congress to continue to block yet another tax on needed services. State and local governments, on the other hand, are unhappy with their inability to apply taxes to Internet and non-Internet services equally, thereby increasing state and local revenues. As you can imagine, this is a no-win situation for Congress, so they maintain the status quo by renewing the ban periodically.

Skype v. Landline Calls

As CRS points out in a recent report, the ban provides a tax advantage to services offered through the Internet. For example, an individual who wants phone service can either buy regular landline service, which is usually subject to state and local sales taxes, or they can purchase Internet access and use a free service, like Skype, to make phone calls and avoid paying taxes. Opponents of the Act cite this inequitable treatment as a principal reason to allow it to expire.

Billions at Stake

One estimate suggests that the moratorium on Internet access taxes reduces potential state and local revenues by as much as $6.5 billion each year. As you can imagine, state and local governments are anxious to impose their sales taxes on the monthly payments that consumers make to their ISP, such as Comcast or AT&T, in exchange for access to the Internet. The moratorium prohibits taxes on Internet access services regardless of whether the tax is imposed on the consumer or the provider. The National Conference of State Legislatures yearly issues a position paper arguing that Congress should not extend the moratorium unless it at the same time requires businesses to collect sales taxes on all internet sales.

Moratorium on Multiple or Discriminatory Taxes

The Act also prohibits state and local governments from imposing multiple or discriminatory taxes on electronic commerce. The ban on multiple taxes prohibits more than one state, or more than one local jurisdiction at the same level of government (i.e., more than one county or city), from

taxing the same transaction, unless a credit is offered for taxes paid to the other jurisdiction. The prohibition on discriminatory taxes bans additional taxes or a different tax rate on a good, service, or information delivered electronically that would differ from the tax or rate applied to

the same good, service, or information if it were purchased through traditional commerce (e.g., brick and mortar stores, catalog sales).

In other words, the same tax rate must be applied to similar items regardless of how they were purchased. For example, purchasing a book through a local book store’s website cannot be taxed at a higher rate than purchasing it at the local book store’s physical location.

10,000 Taxing Jurisdictions

If Congress ever decides to step out of the way and let state and local governments tax internet services, internet service providers could face collecting taxes for upwards of 10,000 taxing jurisdictions across the country. This estimate is provided by the Internet Tax Freedom Act Coalition, which is the point organization supporting a permanent ban on state and local taxation of the internet. The group notes that state taxes on communications services are already high—about 17% on telephone/voice services and 12% on cable/video services.

Outlook

In December, Congress is again faced with making a decision on extending the internet tax ban. Although there have been several bills passed to permanently extend the ban, none have made it through both Houses of Congress. So, you can expect that Congress will continue to “patch” the problem for short periods of time. Our guess is that Congress will extend for one more year – until after the November 2016 elections. Then, the process will start over again.

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