Order Code RL31929
CRS Report for Congress
Received through the CRS Web
Internet Taxation:
Issues and Legislation
in the 108th Congress
Updated May 4, 2004
Steven Maguire
Analyst in Public Finance
Government and Finance Division
Nonna A. Noto
Specialist in Public Finance
Government and Finance Division
Congressional Research Service ˜ The Library of Congress

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Internet Taxation: Issues and Legislation
in the 108th Congress
Summary
The Internet Tax Freedom Act (ITFA), enacted in October 1998 and extended
for two years in November 2001, expired on November 1, 2003. The federal
moratorium prohibited state and local governments from levying new taxes on
Internet access and any multiple or discriminatory taxes on electronic commerce.
Taxes on Internet access that were in place before October 1, 1998, were protected
by a grandfather clause.
The House approved H.R. 49 by voice vote, under a suspension of the rules, on
September 17, 2003. H.R. 49 as passed would (1) permanently extend the
moratorium; (2) eliminate the grandfathering protections, and (3) exempt from state
and local taxes any form of telecommunications used to provide Internet access. The
bill introduced by Representative Cox was replaced by a technical amendment in the
Subcommittee on Commercial and Administrative Law and further amended by the
Judiciary Committee to provide for neutrality in the tax ban across all modes of
Internet access. The Congressional Budget Office (CBO) found that H.R. 49 would
impose an intergovernmental mandate because existing taxes would not be granted
grandfathering protection.
The Senate approved S. 150 (93-3) on April 29, 2004. The final version of S.
150 is significantly different than the version first introduced. The Senate adopted
the McCain substitute amendment (S.Amdt. 3048) with some important
modifications and added the requirement that the General Accounting Office (GAO)
study “...effects of [the] Internet tax moratorium on state and local governments and
broadband deployment.” In addition to the GAO study, S. 150 would (1) extend the
moratorium four years, through November 1, 2007; (2) expand the definition of
Internet access to include both providers and buyers of Internet access; (3)
grandfather Internet access taxes enforced before October 1, 1998 through November
1, 2007; (4) grandfather Internet access taxes enforced before November 1, 2003
(primarily taxes on DSL Internet access service) through November 1, 2005; and (5)
exclude taxes on voice or similar service utilizing Internet Protocol.
The Bush Administration supports permanent extension of the moratorium.
An issue previously raised in connection with the Internet tax moratorium is
streamlined sales taxes and remote tax collection authority. Companion bills H.R.
3184 and S. 1736 would grant states that comply with the Streamlined Sales and Use
Tax Agreement (a multistate compact) the authority to require remote sellers to
collect state and local taxes on interstate sales. A related issue is whether and how
to have Congress set the nexus standards under which a state is entitled to impose its
business activity tax (BAT, e.g., corporate income tax) on a company located outside
the state but with business activities in the state. H.R. 3220 would establish a
physical presence standard for business activity taxes. This report will be updated
as legislative events warrant.

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Contents
Background . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1
Issues . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1
The Moratorium: Permanent vs. Temporary Extension, or Sunset? . . . . . . . 2
Grandfathering of Existing Access Taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . 3
Definitions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4
Taxation of Internet Access . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4
Multiple Taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6
Discriminatory Taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6
Streamlined Sales Taxes and Remote Collection Authority . . . . . . . . . . . . . 7
Business Activity Tax (BAT) Nexus Standards . . . . . . . . . . . . . . . . . . . . . . 9
Action in Congress . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10
Moratorium Legislation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10
H.R. 49 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10
H.R. 1481 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12
S. 52 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12
S. 150 (early versions) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12
S. 150 (approved final version) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13
S. 2084 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13
S. 2281 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14
S. 2348 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14
Internet Commerce Related Legislation . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14
H.R. 3184 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14
H.R. 3220 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14
S. 1736 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14
For Additional Information . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16
Hearings in the 108th Congress . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16
CRS Reports . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16
List of Tables
Table 1. Comparison of Internet Tax Bills in the House and Senate . . . . . . . . . 15
Table 2. Bills on Internet Related Tax Issues in the House and Senate . . . . . . . 15

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Internet Taxation: Issues and Legislation
in the 108th Congress
Background
The Internet Tax Freedom Act (ITFA) was enacted on October 21, 1998, as
Title XI of Division C of P.L. 105-277, the Omnibus Consolidated and Emergency
Supplemental Appropriations Act, 1999.1 The ITFA placed a three-year moratorium
on the ability of state and local governments to (1) impose new taxes on Internet
access or (2) impose any multiple or discriminatory taxes on electronic commerce.
The act grandfathered the state and local access taxes that were “... generally imposed
and actually enforced prior to October 1, 1998 ....”
This Internet tax moratorium expired on October 21, 2001. The Internet Tax
Nondiscrimination Act, P.L. 107-75, was enacted on November 28, 2001. It
provided for a two-year extension of the prior moratorium, through November 1,
2003 (the moratorium has expired). It also continued the grandfathering protection
for pre-existing Internet access taxes. More recently, the House passed H.R. 49 on
September 17, 2003. H.R. 49 would make the moratorium permanent, significantly
broaden the definition of Internet access, and eliminate all grandfathering protections.
The Senate approved S. 150 (93-3) on April 29, 2004. S. 150 would extend the
moratorium for four years, grandfather pre-October 1, 1998 taxes through November
1, 2007, and grandfather pre-November 1, 2003 taxes through November 1, 2005.
A House-Senate conference on the moratorium legislation has not been scheduled.
Issues
The five main issues surrounding Internet taxation are as follows:
! the moratorium on Internet access taxes, either temporary or
permanent extension;
! whether to grandfather the moratorium for states that imposed taxes
on Internet access before the original moratorium was imposed (if
the moratorium is retained);
! defining Internet access and discriminatory taxes to the satisfaction
of all stakeholders;
1 Title XII was also part of S. 442, 105th Congress, the underlying ITFA legislation. Titles
XI and XII, 112 Stat. 2681-719 through 728 (1998). Title XI is codified as the ITFA in 47
U.S.C. 151 note. Title XII is codified as 19 U.S.C. 2241 note.

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! granting states the authority to require remote sellers to collect use
taxes if the states adopt a streamlined sales tax system; and
! Congressional codification of guidelines for establishing whether or
not a business engaged in interstate commerce has nexus in a
jurisdiction for purposes of business activity taxes (BATs, e.g.,
corporate income tax) liability.2
The Moratorium: Permanent vs. Temporary Extension,
or Sunset?
The intent of the Internet Tax Freedom Act enacted in 1998 was to prevent state
taxes on Internet access, to ensure that multiple jurisdictions could not tax the same
electronic commerce transaction, and to ensure that commerce over the Internet
would not be singled out for discriminatory tax treatment. Supporters of the
moratorium felt that the Internet should be protected from the administrative and
financial burdens of taxation to encourage the advance of Internet technology and
associated economic activity. Opponents contended that a federal moratorium
infringed on the states’ independent authority to levy taxes and that Internet
transactions and services should not be afforded differential tax treatment.
A permanent extension of the moratorium would eliminate the need for
Congress to revisit the issues surrounding Internet taxation when a temporary
moratorium expired. Permanent extension presumably could also provide both the
producers and consumers of Internet services greater certainty about state and local
taxation of the Internet. Opponents contend, however, that a permanent extension
does not address the underlying issue of federal restrictions on state taxation and the
clarification of the definition of Internet access.
In contrast, a temporary extension of the moratorium would allow Congress to
periodically review the conditions of the moratorium and the effect of the
moratorium on the states. The reassessment could be made in the context of
developments in computer technology and business organization, as well as state and
local government revenues. A temporary extension would also provide time for the
states to simplify further their sales and use taxes. (See the discussion below on
Streamlined Sales Taxes and Remote Collection Authority.)
Allowing the moratorium to sunset would permit the states to tax Internet
access, although, in practice, the trend has been for states to repeal their Internet
access taxes. As Internet technology continues to change the telecommunications
industry, however, state and local governments will likely have to modify how the
2 The issues remain similar to those considered in 2001, when the Internet tax moratorium
was temporarily extended for two years. For a longer discussion of the extension of the
moratorium, grandfathering of existing access taxes, and collecting sales and use taxes on
interstate sales — in relation to bills introduced in the first session of the 107th Congress —
see CRS Report RL31177, Extending the Internet Tax Moratorium and Related Issues, by
Nonna A. Noto.

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telecommunications industry is taxed. A sunset of the moratorium could induce
states to address the taxation of telecommunications more broadly.
Grandfathering of Existing Access Taxes
The Internet Tax Freedom Act exempted from the moratorium taxes on Internet
access that were “... generally imposed and actually enforced prior to October 1,
1998....” When ITFA legislation was being considered in the spring of 1998, 10
states and the District of Columbia were already applying sales and use tax to Internet
access services.3 Subsequently, Connecticut, Iowa, and the District of Columbia
eliminated their tax on Internet access, and South Carolina has not enforced the
collection of its tax during the federal moratorium. This left seven states imposing
a sales and use tax on Internet access as of April 2003: New Mexico, North Dakota,
Ohio (on businesses only, not consumers), South Dakota, Tennessee, Texas (on
monthly charges over $25), and Wisconsin.4 In addition, Hawaii levies its general
excise tax, New Hampshire its communications services tax (imposed on all two-way
communications equipment), and Washington state its business and occupation tax
(a gross receipts tax levied on business) on Internet access.
The grandfathering protection was continued when the ITFA moratorium was
extended for two years in 2001 (through November 1, 2003). The issue now is
whether the grandfathering for Internet access taxes will be continued if the
moratorium is renewed, either temporarily or permanently. A second grandfathering
issue has arisen as states began to tax Internet access provided through digital
subscriber lines (DSL). DSL is considered a telecommunication service and was
exempt from the original moratorium. H.R. 49, as passed by the House, would
eliminate the grandfathering protections. S. 150, would extend the grandfathering
protection for pre-1998 taxes through November 1, 2007 and grandfather DSL
service taxes through November 1, 2005.
In its cost estimates for H.R. 49, the Congressional Budget Office (CBO)
determined that eliminating the grandfathering protection for pre-1998 access taxes
would impose an intergovernmental mandate as defined in the Unfunded Mandates
Reform Act (UMRA, P.L. 104-4, 2 U.S.C. 1501-1571).5 According to CBO, the
prohibition of pre-1998 taxes on Internet access that are currently being collected in
up to 10 states and a few local jurisdictions in six states, would cost these
jurisdictions approximately $80 million to $120 million per year. This estimate alone
exceeds the UMRA threshold of $59 million in 2003, in the case of H.R. 49, and $64
million in 2007 (adjusted annually for inflation), in the case of S. 150. CBO noted
that additional state and local revenues could be lost if more telecommunications
services and information content were redefined as Internet access.
3 National Conference of State Legislatures, “Which States Tax Internet Access?” March
25, 1998, available at [http://www.ncsl.org/programs/fiscal/intertax.htm].
4 Vertex, Inc., Tax Cybrary, available at [http://www.vertexinc.com].
5 Congressional Budget Office, “Cost Estimate for H.R. 49, Internet Tax Nondiscrimination
Act,” as ordered reported by the House Committee on the Judiciary on July 16, 2003,
Washington, July 21, 2003. Available at [http://www.cbo.gov].

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The proposed expansion of the moratorium to include some telecommunications
services (through redefining Internet access) except to the extent such services are
used to provide Internet access, would affect those states that currently tax digital
subscriber line (DSL) services. A recent study reported that 27 states and the District
of Columbia are currently collecting taxes on DSL Internet access services.6
Definitions
The ITFA tax moratorium prohibits new taxes on Internet access and multiple
or discriminatory taxes on electronic commerce. The act’s definitions of Internet
access and of discriminatory tax, in particular, have been the source of some concern
and legal uncertainty for state and local governments, providers of new-technology
Internet access service, telecommunications companies offering bundled
communications and information services, supporters of federal and state universal
service programs, and companies with “dot.com” subsidiaries.
Taxation of Internet Access. The taxation of Internet access most
commonly refers to the application of state and local sales taxes to the monthly
charges that retail subscribers pay for access to the Internet through Internet service
providers (ISPs) such as America Online (AOL), Microsoft Network (MSN), or
EarthLink. Some examples can help illustrate the size of the tax burden at issue. If
the tax were levied at a combined state and local sales tax rate of 7%, the tax on a
dial-up modem service costing $22 per month would be $1.54 per month or $18.48
per year. On a cable modem service costing $40 per month, the tax would be $2.80
per month or $33.60 per year. On a DSL (digital subscriber line) service costing $55
per month, the tax would be $3.85 per month or $46.20 per year.7
Bundling of Services. According to Section 1104(5) of the Internet Tax
Freedom Act,
The term “Internet access” means 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 users. Such term does not include
telecommunications services.
The breadth of the definition in the first sentence gives rise to concern on the
part of state and local revenue departments that the tax-protection of Internet access
may extend to “bundled” products and services that might otherwise be taxable if
purchased on their own. These could include data and information services, cable
television, books, magazines, games, music, video on demand, and Internet
6 Michael Mazerov, “Making the Internet Tax Freedom Act Permanent in the Form
Currently Proposed Would Lead to a Substantial Loss for States and Localities,” Center on
Budget and Policy Priorities, Oct. 20, 2003.
7 Monthly prices from the 2003 Internet Service Provider (ISP) Directory, Washington Post,
Feb. 2, 2003, p. H10. Common state-local sales tax rate selected from Federation of Tax
Administrators, Comparison of State and Local Retail Sales Taxes, Jan. 2003. Available
at [http://www.taxadmin.org/fta/rate/sl_sales.html]. Calculation of sample tax bills by CRS.

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telephony. These types of products and services can be offered online and sold as
part of an Internet access service that is protected from taxation.
Telecommunications Industry Concerns. Telecommunications carriers
are concerned that Internet access offered through some technologies, such as DSL
or wireless services, might not be treated as exempt, while access offered over other
technologies, such as cable modem, would be exempt. In an attempt to address these
claims, both H.R. 49 and S.150 would provide that all forms of telecommunications
services used to provide Internet access would be exempt from state and local taxes,
that is, included in the moratorium.8
State and local governments are concerned, however, that the revised language
would broaden the current tax exemption far beyond retail Internet access. The
expanded definition could also exempt not only the services that connect the
consumer to the Internet, but also all of the telecommunications services that
compose the Internet backbone. While not quantifying the likely cost, CBO indicated
that this interpretation of H.R. 49 could adversely affect state and local revenues
enough to create an unfunded intergovernmental mandate.
A report issued on September 24, 2003, by the Multistate Tax Commission
(MTC) estimated that H.R. 49 would cost state and local governments from $4
billion to $8.75 billion annually by 2006. This estimate does not include potential
losses from bundling of services. It does include the reduction of sales, excise,
income, property, and other business taxes on Internet access and
telecommunications. In contrast, if the moratorium were limited to sales taxes on
solely Internet access to customers (the so-called last mile of service), including
broadband, and removing the grandfathering, the cost would be limited to
approximately $500 million in 2006.9
In a study released October 20, 2003, the Center on Budget and Policy Priorities
estimated that 27 states and the District of Columbia could lose approximately $70
million per year if they could no longer tax DSL telephone service. The
telecommunication services used by Internet access providers to link to the Internet
“backbone” could no longer be taxed. In addition, with the growth of Internet
telephony (voice over Internet protocol, VOIP), there would be less traditional
telephone service (POTS) remaining in the tax base. Currently, state and local taxes
on voice telephone services produce $12 billion in annual revenues.10
8 For more information, see U.S. Congress, Senate Committee on Commerce, Science, and
Transportation, Internet Tax Non-discrimination Act of 2003, Report on S. 150, S.Rept. 108-
155, 108th Cong., 1st sess., Sept. 29, 2003 (Washington: GPO, 2003).
9 Dan Bucks, Elliott Dubin and Ken Beier, “Revenue Impact on State and Local
Governments of Permanent Extension of the Internet Tax Freedom Act” (Washington:
Multistate Tax Commission), Sept. 24, 2003, available at [http://www.mtc.gov].
10 Michael Mazerov, “A Permanent Ban on Internet Access Taxation Risks Serious Erosion
of States and Local Telephone Tax Revenue as Phone Calls Migrate to the Internet,” Center
on Budget and Policy Priorities, Feb. 11, 2004, p. 1.

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Funding Universal Service. Some members of Congress are concerned
about protecting the financing source for the Universal Service Fund (USF).11 The
USF is administered by the Universal Service Administrative Company, an
independent not-for-profit organization under the auspices of the Federal
Communications Commission (FCC). The USF is financed by mandatory
contributions from interstate telecommunications carriers.12 A company’s USF
contribution is a percentage13 of its interstate and international end-user revenues.
Some states also levy charges on the intrastate retail revenues of telecommunications
carriers for their state’s universal service fund.14
Supporters of the universal service programs are concerned that efforts to
protect Internet access and associated telecommunications services should not reduce
the funding base for universal service. S. 150 would not prevent the federal
government or the states from imposing or collecting the fees or charges on
telecommunications that are used to finance the universal service program codified
(in 1996) by Section 254 of the Communications Act of 1934.
Multiple Taxes. In order to eliminate the possibility of double taxation of
electronic commerce transactions, 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 one city) from imposing a tax on the same transaction — unless
a credit is offered for taxes paid to another jurisdiction. However, the state, county,
and city in which an electronic commerce transaction takes place could all levy their
sales taxes on the transaction. There has not been much controversy over this
definition and restriction.
Discriminatory Taxes. In practice, the ban on discriminatory taxes on
electronic commerce means that transactions arranged over the Internet are to be
taxed in the same manner as mail order or telephone sales. Under the current judicial
11 The USF subsidizes telephone service to low income consumers and to high-cost rural and
insular areas. Through the E-rate or education-rate program instituted by the
Telecommunications Act of 1996, the USF also subsidizes telecommunications discounts
for schools and libraries. Also as a result of the 1996 Act, the USF subsidizes
communications links between rural health care providers and urban medical centers. For
further information on the E-rate program, see CRS Issue Brief IB98040,
Telecommunications Discounts for Schools and Libraries: The “E-Rate” Program and
Controversies, by Angele A. Gilroy.
12 All telecommunications providers that provide service between states must contribute to
the USF. This includes long distance companies, local telephone companies, wireless
telephone companies, paging companies, and payphone providers.
13 The percentage, known as the contribution factor, is set quarterly, and varies depending
on the financing needs of the universal service programs. The federal universal service
contribution factor for the third quarter of 2003 was 0.095 or 9.5%. The proposed
contribution factor for the fourth quarter of 2003 was 0.092 or 9.2%. Federal
Communications Commission, Contribution Factors and Quarterly Filings, available at
[http://www.fcc.gov/wcb/universal_service/quarter.html].
14 State charges are typically levied on the intrastate retail revenues of wireline carriers and,
in some states, wireless carriers as well.

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interpretation of nexus as applied to mail-order sales, a state cannot require an out-of-
state seller to collect a use tax from the customer unless the seller has a physical
presence in the taxing state.15 (A use tax is the companion tax to the sales tax,
applicable to interstate sales.) Congress or the Supreme Court would need to act to
grant or approve the states’ ability to require out-of-state tax collection, whether the
transaction was arranged over the Internet or by mail-order, telephone, or other
means.
The second part of the ITFA’s definition of discriminatory tax lists conditions
under which a remote seller’s use of a computer server, an Internet access service, or
online services does not establish nexus. These circumstances include the sole ability
to access a site on a remote seller’s out-of-state computer server; the display of a
remote seller’s information or content on the out-of-state computer server of a
provider of Internet access service or online services; and processing of orders
through the out-of-state computer server of a provider of Internet access service or
online services. Some businesses have taken advantage of these nexus limits in the
ITFA’s definition of discriminatory tax to establish what are referred to as Internet
kiosks or dot-com subsidiaries. The businesses claim that these Internet-based
operations are free from sales and use tax collection requirements. Critics object that
these methods of business organization are an abuse of the definition of
discriminatory tax.
Streamlined Sales Taxes and Remote Collection Authority
In the 106th and 107th Congresses, the debate surrounding moratorium extension
legislation was linked to the states’ quest for sales and use tax collection authority.
The issue was Congress’s willingness eventually to grant states the authority to
require remote (out-of-state) sellers to collect use taxes on interstate sales. States
would need to simplify their state and local sales and use tax systems for Congress
to grant this authority.
Under current law, a vendor with substantial nexus (usually defined as physical
presence) in its customer’s state collects the state (and local) sales tax on sales
arranged over the Internet (or by telephone, mail order, or other means). In contrast,
an out-of-state vendor without substantial nexus in the customer’s state is not
required to collect the sales tax.16 Technically, the customer is required to remit a
“use” tax to his or her state of residence.17 In practice, however, use tax compliance
by non-business purchasers is low. Because of this low compliance, many states
have long wanted to require out-of-state vendors without physical presence in the
respective states (referred to as remote sellers) to collect the use tax from the
15 For additional discussion, see CRS Report RS20577, State Sales Taxation of Internet
Transactions, by John R. Luckey.
16 In 1967 and again in 1992, the Supreme Court concluded that the complexity of the state
and local sales tax systems imposed an undue burden on interstate commerce. See the
following decisions for more: National Bellas Hess Inc., v. Illinois Department of Revenue,
386 U.S. 753 (1967) and Quill Corp. v. North Dakota, 504 U.S. 298 (1992).
17 The use tax is the companion tax to the sales tax and was created to ensure that cross
border transactions are not favored in the state tax code.

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customer. This would apply to all interstate sales, whether arranged over the Internet
or by catalog, telephone, or other means.
Acknowledging administrative complexity as a major obstacle to remote
collection, the states began a concerted effort to simplify state and local sales and use
tax through the Streamlined Sales Tax Project (SSTP). The project commenced in
March 2000, midway through the initial ITFA moratorium (October 1998 - October
2001). The SSTP continued its work after the moratorium was extended in
November 2001. On November 12, 2002, 34 states and the District of Columbia
approved a model interstate agreement to simplify their sales tax systems, known as
the Streamlined Sales and Use Tax Agreement. The agreement establishes uniform
definitions for taxable goods and services and requires that a participating state and
local government have only one statewide tax rate for each type of product by 2006.
Each state would retain the power to define taxable products and establish the tax
rate. The agreement provides for streamlined tax administration and audit
requirements for sellers.
During their 2003 sessions, individual state legislatures considered legislation
to bring their own state and local sales tax laws into conformity with the model tax
agreement. For the agreement to come into effect, at least 10 states representing at
least 20% of the combined population of the 45 states with state sales taxes were
required to petition for membership into the agreement and be found to be in
conformance with the agreement. (There is some question about whether in order to
qualify as conforming, 10 states must simply approve the agreement or must actually
change the administration of their sales tax systems to conform with the agreement.)
As of January 2004, 20 states had enacted legislation conforming with all or part of
the agreement.18 The combined population of these 20 states represents
approximately 30% of the population of states with sales taxes.
Separately, a coalition of a few nationwide sellers reached agreements with 38
states and the District of Columbia to begin collecting their use taxes voluntarily,
starting February 3, 2003, in exchange for amnesty on previously uncollected taxes.
Among the retailers participating initially were Wal-Mart Stores Inc., Target Corp.,
and Toys R Us Inc. Other retailers have entered into similar voluntary agreements.
In the 106th and 107th Congresses, bills were introduced that enumerated criteria
for a simplified sales and use tax system and procedures for Congress to grant tax
collection authority — in conjunction with an extension of the moratorium. In the
108th Congress, the sales tax issue is being pursued separately from the moratorium.
Companion bills H.R. 3184 (Istook and Delahunt) and S. 1736 (Enzi) would grant
states that comply with the Streamlined Sales and Use Tax Agreement the authority
to require remote sellers to collect state and local use taxes on interstate sales.
The chairmen of the committees of jurisdiction in both the House and Senate
have indicated that they want to pursue the moratorium extension independently from
18 Streamlined Sales Tax Project, State Legislative Status of Streamlined Sales and Use Tax
Agreement (as of January 2004). Available at [http://www.streamlinedsalestax.org] under
St. Legislative Status.

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the sales tax issue. Representative Cannon, Chairman of the Subcommittee on
Commercial and Administrative Law of the House Judiciary Committee, and Senator
McCain, Chairman of the Senate Committee on Commerce, Science, and
Transportation, each indicated that his committee would hold a hearing on the sales
tax issue, in addition to the hearing held on the moratorium extension. The House
Subcommittee on Commercial and Administrative Law held an oversight hearing on
October 1, 2003, titled “The Streamlined Sales Tax Agreement: States’ Efforts to
Facilitate Sales Tax Collection from Remote Vendors.”
Business Activity Tax (BAT) Nexus Standards
The possibility that states could be authorized to require remote vendors to
collect sales and use taxes on interstate sales has raised concerns that states would
then attempt to impose income and other business taxes on those vendors. In
response, some multistate businesses have asked Congress to clarify nexus standards
for state and local business activity taxes (BATs).19 Past court decisions and the
landmark P.L. 86-272 established physical presence as the standard for sufficient
nexus, but only for the sale of tangible goods.
Congress clarified nexus in P.L. 86-272 by identifying those activities which
would not establish nexus. Generally, soliciting the sale of tangible goods in a state
for shipment by common carrier from locations outside the state, would not be
sufficient to trigger nexus. Thus, for products shipped across state lines, state net
corporate income taxes are levied at the source, not the destination, of the product.
Proponents of federally defined nexus standards contend that current federal law
does not sufficiently define substantial nexus. The issue before Congress is whether
to codify nexus rules for all goods and services, not just tangible goods. Currently,
each state independently implements rules for economic activities — which are not
covered by P.L. 86-272 — that establish nexus. Although state rules are very similar
for many services and activities, there is still significant variation from state to state
on the threshold for establishing nexus. In theory, Congress could establish uniform
federal standards for the imposition of state business activity taxes on out-of-state
businesses.
Some representatives of state and local governments, however, are concerned
that enacting nexus guidelines could restrict their ability to levy corporate income
taxes (or other BATs) on business activities conducted in their state. For example,
if Congress implemented thresholds at the midpoint level of all existing state nexus
rules, by definition, many states would lose taxpayers that did not meet the new
standard for substantial nexus. The states with the lowest thresholds would fare the
worst under such a scenario.
The remote collection authority bills offered in earlier Congresses typically
provided that out-of-state vendors that collected sales and use taxes, would not then
19 Business activity taxes are commonly thought of as corporate income taxes, but may also
include franchise taxes, business license taxes, business and occupation taxes, apportionable
gross receipts taxes, value-added taxes, single business taxes, and capital stock taxes.

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be subject to business activity taxes by virtue of their tax collection for the state.
Thus far in the 108th Congress, as in the past, the BAT nexus issue is being addressed
separately from both the extension of the Internet tax moratorium and the sales tax
simplification issue.
Action in Congress
Moratorium Legislation
Several bills to extend the Internet tax moratorium were introduced in the 108th
Congress. H.R. 49 was amended and reported by the House Judiciary Committee on
July 16, 2003, and approved by the House on September 17. S. 150 was amended
and approved by the Senate on April 29, 2004.
Both H.R. 49 and S. 150 would expand the definition of Internet access to
ensure technological neutrality. The two bills differ on the treatment of existing
Internet access taxes and the length of the moratorium. H.R. 49 would impose a
permanent moratorium and would immediately remove the grandfathering protection
offered under current law to states that had Internet access taxes in place prior to
October 1, 1998. S. 150, in contrast, would impose a four-year moratorium, would
extend the grandfathering for pre-1998 taxes for the life of the moratorium (four
years) and grandfather pre-2003 taxes for two years.
Early in 2004, three additional Internet moratorium related bills were
introduced. S. 2084 would extend the moratorium for two years, through November
1, 2005, and would grandfather existing state and local taxes on Internet access. S.
2348 would extend the moratorium, without modifications to the original ITFA,
through June 1, 2005. S.Amdt. 3048 (the approved McCain amendment to S. 150)
would extend the moratorium four years (through November 1, 2007) and would
follow most of the language included in S. 150. The more narrowly focused S. 2281
would ban state and local taxation of most VOIP services. Following is a summary
of selected Internet related legislation.
H.R. 49. A hearing on H.R. 49 was held by the House Judiciary Committee,
Subcommittee on Commercial and Administrative Law, on April 1, 2003.
Subcommittee consideration and markup occurred on May 22, 2003. A technical
amendment in the nature of a substitute was approved by voice vote. The amended
H.R. 49 was forwarded to the full committee after approval by voice vote.
On July 16, 2003, the House Judiciary Committee held a markup of H.R. 49,
approved one amendment, and reported the amended H.R. 49 to the full House. The
approved amendment was introduced on a bipartisan basis by Representative Watt

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and Subcommittee Chairman Cannon.20 It is intended to provide technological
neutrality in the exemption from taxes on Internet access, without regard to the
means by which Internet access is delivered. The amendment added to the definition
of Internet access (in Section 1104(5) of the Internet Tax Freedom Act) the phrase
shown below in italic type:
(5) INTERNET ACCESS. — The term “Internet access” means 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 users. Such term does not include telecommunications services, except to the
extent such services are used to provide Internet access.21 [Emphasis added.]
The amendment intended to treat all Internet access services, that is, DSL,
wireless services (WiFi), or satellite, the same as Internet access service delivered via
dial-up connections. However, the language of the amendment could also exempt
underlying telephone and cable services used to provide Internet access. These
underlying telecommunications services are often taxed by state and local
governments. Furthermore, with the removal of the grandfather clause that protects
taxes on Internet access that were generally imposed and actually enforced prior to
October 1, 1998, the moratorium might also be interpreted to include business
activity taxes, such as income and property taxes, on Internet access providers.
In its cost estimate of July 21, 2003, the Congressional Budget Office (CBO)
determined that H.R. 49, as ordered reported by the House Judiciary Committee,
would impose an intergovernmental mandate. CBO estimated that repealing the
grandfather clause would lead to revenue losses (on Internet access) totaling $80
million to $120 million per year for the group of approximately 10 states and several
local governments in the states that currently tax Internet access. This amount alone
exceeds the threshold of $59 million in 2003 established by the Unfunded Mandates
Reform Act (UMRA). In addition, amending the definition of Internet access (with
the Watt-Cannon amendment) could exempt some telecommunications services used
to provide Internet access that are otherwise subject to state and local taxes under
20 The language of the Watt-Cannon amendment that was approved in the full Judiciary
Committee was different from the Watt amendment introduced but withdrawn in the
Subcommittee on Commercial and Administrative Law.
21 The highlighted phrase was also added to the definition of Internet access services in
Section 1101(e)(3)(D) of the Internet Tax Freedom Act. This pertains to the exception to
the moratorium for making communications for commercial purposes that include material
harmful to minors, if access by minors is not restricted. The addition of the phrase keeps
the definition of Internet access service similar to the definition of Internet access in the
ITFA. However, in this section the phrase may be redundant, because under Section
1101(e)(2) neither (A) a telecommunications carrier engaged in the provision of a
telecommunications service, nor (B) a person engaged in the business of providing an
Internet access service, is considered as making a communication of material for commercial
purposes.

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current ITFA law.22 The presence of an unfunded intergovernmental mandate in
excess of the threshold amount means that a point of order may be raised when a bill
is considered on the House or Senate floor.23
H.R. 49 was brought to the House floor on September 17, 2003, under a
suspension of the rules. This procedure, designed for noncontroversial bills, provides
for an up-or-down vote with no floor amendments and requires a two-thirds majority
vote. Despite objections from representatives of states with grandfathered Internet
access taxes, the House passed H.R. 49, as reported by the Judiciary Committee, by
voice vote.24
H.R. 1481. Internet Growth and Freedom Act of 2003. H.R. 1481 would
temporarily extend the moratorium imposed by the Internet Tax Freedom Act for five
years, until November 1, 2008. The bill would continue the grandfather protection
for pre-existing Internet access taxes. H.R. 1481 was introduced March 27, 2003,
and referred to the Committee on the Judiciary.
S. 52. Internet Tax Nondiscrimination Act. S. 52 would permanently extend
the moratorium imposed by the Internet Tax Freedom Act. This bill would remove
the grandfathering protection for taxes on Internet access that were generally imposed
and actually enforced prior to October 1, 1998, by removing from the ITFA the
grandfather clause and the definition of generally imposed and actually enforced
taxes. This bill is the companion to H.R. 49 and was introduced on January 7, 2003.
S. 52 was referred to the Committee on Commerce, Science, and Transportation.
S. 150 (early versions). On July 16, 2003, the Senate Committee on
Commerce, Science, and Transportation held a hearing on S. 150. On July 31, 2003,
the Senate Commerce Committee marked up the bill. An amendment in the nature
of a substitute offered by Senator Allen and co-sponsor of S. 150, Senator Wyden,
was approved by voice vote and the amended bill was ordered reported favorably.
On September 29, S. 150 was reported by the Commerce Committee (S.Rept. 108-
155) and sequentially referred to the Finance Committee for a period of up to 30
days. The bill was discharged from the Finance Committee with no changes.
The first two sections of S. 150 as amended by the Commerce Committee were
similar to H.R. 49 as passed by the House. The first section names the bill the
Internet Tax Non-discrimination Act. The second section would permanently extend
the moratorium, remove the grandfathering protection for existing taxes on Internet
access, and make conforming amendments to remove the reference to grandfathered
taxes elsewhere in the ITFA. It would add to the definitions of Internet access and
Internet access services the phrase “...except to the extent such services are used to
22 Congressional Budget Office, “Cost Estimate for H.R. 49, Internet Tax Nondiscrimination
Act.”
23 For an explanation of congressional procedures required under UMRA, see CRS Report
RS20058, Unfunded Mandates Reform Act Summarized, by Keith Bea and Richard S. Beth,
Washington, Feb. 9, 1999, pp. 4-5.
24 Alison Bennett, House Passes Permanent Extension Of Existing Internet Tax Moratorium,
Daily Tax Report, Bureau of National Affairs, no. 81, Sept. 18, 2003, p. GG-1.

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provide Internet access” following “telecommunications services,” just as was added
to H.R. 49 by the Watt-Cannon amendment in the House Judiciary Committee.
Senators Allen and Wyden have agreed to refine the definition of Internet access to
better reflect their intentions that it is Internet access that is protected from tax and
not the underlying communications medium. They also intend that the moratorium
be neutral with respect to whatever technology is used to provide Internet access.
The Commerce Committee report on S. 150 spelled out the committee’s intentions
with regard to the amended definition of Internet access.25
In addition, S. 150 as ordered reported included a third section that would
continue to grandfather existing taxes on Internet access for three more years, until
September 30, 2006. A fourth section of the bill clarifies that the ITFA does not
prevent the federal government or the states from imposing or collecting the fees or
charges on telecommunications that are used to finance the universal service program
authorized by Section 254 of the Communications Act of 1934.
For reasons similar to those given above with respect to H.R. 49, in its cost
estimate of September 9, 2003 for S. 150, the Congressional Budget Office
determined that the bill as ordered reported by the Senate Committee on Commerce,
Science, and Transportation would impose an intergovernmental mandate, beginning
in 2007, once the grandfathering protection was removed.26 This means that a point
of order could be raised when the bill is considered on the Senate floor. The Senate
began consideration of S. 150 on November 6. The bill was pulled on November 7
for further negotiation on the definition of Internet access.
S. 150 (approved final version). On April 27, Senator McCain offered a
compromise amendment to S. 150, S.Amdt. 3048. The McCain amendment was
modified slightly leading to a final version of S. 150 that would (1) extend the
moratorium four years, through November 1, 2007; (2) expand the definition of
Internet access to include both providers and buyers of Internet access; (3)
grandfather Internet access taxes enforced before October 1, 1998 through November
1, 2007; (4) grandfather Internet access taxes enforced before November 1, 2003
(primarily taxes on DSL Internet access service) through November 1, 2005; and (5)
exclude taxes on voice or similar service utilizing Internet Protocol.
25 The modified definition of Internet access is meant to clarify that, under the ITFA, neither
Internet access nor the transmission component of Internet access is subject to taxation.
(Neither the access nor transmission component of DSL would be taxable.) This definition
is not meant to affect state and local taxation of traditional telecommunications and other
services not used to provide Internet access. It is not meant to exempt from state or local
taxation otherwise taxable products or services bundled with Internet access. The lapse of
grandfathering protection is not meant to affect the authority of state and local governments
to assess and collect traditional sales and use taxes, excise taxes, property taxes, corporate
income taxes, gross receipts taxes, business and occupational taxes, and other such taxes
generally applied and not enumerated in section 1101(a) of the ITFA. U.S. Congress, Senate
Committee on Commerce, Science, and Transportation, report on S. 150, S.Rept. 108-155,
pp. 2-4.
26 Congressional Budget Office, “Cost Estimate for S. 150, Internet Tax Nondiscrimination
Act.”

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S. 2084. On February 12, 2004, Senators Alexander and Carper introduced S.
2084, which would (1) extend the Internet tax moratorium for two years, (through
October 31, 2005); (2) include in the moratorium taxes on Internet access delivered
through DSL; (3) grandfather all Internet access taxes that were imposed before
November 1, 2003; (4) clarify the definition of Internet access services; and (5)
implement an accounting rule that would allow the taxation of Internet access if
access were offered as part of a bundled package and the access provider did not
separate Internet access charges from the other services. The inclusion of DSL in the
definition of Internet access services addresses the concern that the moratorium
should be neutral with respect to technology. However, the grandfather clause would
allow states that were already levying taxes on DSL Internet access to continue to
collect the tax.
S. 2281. Senator Sununu’s legislation, S. 2281, focuses on the taxation and
regulation of VOIP technology. The legislation would prohibit state taxation and
regulation of VOIP related technology. The legislation would mandate that
“...responsibility and authority to regulate the offering or provision of a voice-over-
Internet-protocol application is reserved solely to the Federal Government.”
S. 2348. Senators Enzi, Feinstein, and Hutchinson, introduced S. 2348, which
would extend the moratorium, without modifications to the original ITFA, through
June 1, 2005. The existing definition of Internet access and what is included in the
moratorium would not be changed by the legislation.
Internet Commerce Related Legislation
H.R. 3184. Streamlined Sales and Use Tax Act. H.R. 3184 is the companion
to S. 1736. H.R. 3184 would grant states that are parties to the Streamlined Sales and
Use Tax Agreement (a multistate compact approved November 12, 2002) the
authority to require remote sellers to collect and remit state and local sales and use
taxes, even if the seller does not have a physical presence in the taxing state. This
bill enumerates 18 minimum simplification requirements that the agreement must
meet. H.R. 3184 was introduced September 25, 2003, and referred to the Committee
on Judiciary.
H.R. 3220. Business Activity Tax Simplification Act of 2003. H.R. 3220
would (1) establish physical presence as the nexus standard for levying state and
local business activity taxes on interstate commerce; (2) amend P.L. 86-272,
approved September 14, 1959, which limits the power of states to impose net income
taxes on interstate commerce; (3) generally require use of employees or property for
more than 21 days per calendar year in a state to establish nexus; (4) enumerate
exempt activities. The bill was introduced on October 1, 2003 and was referred to
Committee on the Judiciary.
S. 1736. The Streamlined Sales and Use Tax Act. S. 1736 is the companion
to H.R. 3184 (see the description of H.R. 3184). The bill was introduced October 15,
2003, and referred to the Committee on Finance.

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Table 1 succinctly compares the Internet tax moratorium bills introduced thus
far in the House of Representatives and in the Senate. Table 2 lists bills on related
Internet tax issues introduced in the House and those in the Senate. All the bills are
described in more detail in the text following the tables.

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Table 1. Comparison of Internet Tax Bills
in the House and Senate
Extension of
Grandfathering
Bill Number
Other Issues
Moratorium
Provisions
H.R. 49
Permanent
No
Extends exemption from Internet
passed in the
access taxes to all forms of
House by voice
telecommunications
vote Sept. 17,
used to provide access.
2003
H.R. 1481
5 years, until
Yes
—
Nov. 1, 2008
S. 52
Permanent
No
—
S. 150
4 years, until
Yes, for pre-1998
Extends exemption from Internet
as approved by
Nov. 1, 2007
taxes through Nov. access taxes to all forms of
the Senate (93-3)
1, 2007 and for
telecomm. used to provide access.
on April 29,
pre-2003 taxes
Clarifies that the ITFA moratorium
2004
through Nov. 1,
does not prevent collection of federal
2005
or state fees or charges used to
finance the USF program and VOIP
is not included in the moratorium.
S. 2084
2 years, until
Yes
Modifies the definition of Internet
Nov. 1, 2005
access services to include DSL.
S. 2281
n/a
n/a
Bans state and local taxation of
VOIP services and prohibits state
regulation or control of VOIP
services.
S. 2348
18 months,
Yes
Simple extension, no other changes
until June 1,
to ITFA.
2005
Table 2. Bills on Internet Related Tax Issues
in the House and Senate
Bill Number
Issue
H.R. 3184
Would grant states that comply with the Streamlined Sales and Use Tax
Agreement the authority to require remote sellers to collect state and local
use taxes on interstate sales, subject to minimum simplification
requirements for the agreement and is the companion to S. 1736.
S. 1736
Companion to H.R. 3184.
H.R. 3220
Would establish physical presence as the nexus standard for levying state
and local business activity taxes on interstate commerce.

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For Additional Information
Hearings in the 108th Congress
U.S. Congress. House. Committee on the Judiciary. Subcommittee on Commercial
and Administrative Law. Internet Tax Nondiscrimination Act. Hearing on H.R.
49. Serial No. 13. 108th Cong., 1st sess., April 1, 2003. Washington: GPO,
2003. 102 p. Available at [http://www.house.gov/judiciary/], visited October
23, 2003.
____. The Streamlined Sales Tax Agreement: States’ Efforts to Facilitate Sales Tax
Collection from Remote Vendors. Oversight hearing, October 1, 2003.
Available at [http://www.house.gov/judiciary/], visited October 23, 2003.
U.S. Congress. Senate. Committee on Commerce, Science, and Transportation.
Internet Tax Moratorium. Hearing. 108th Cong., 1st sess., July 16, 2003. Not
yet published. Written testimony available at [http://commerce.senate.gov],
visited October 23, 2003.
CRS Reports
CRS Electronic Briefing Book, Taxation, Internet Taxation, “Taxing Internet
Transactions,” available at [http://www.congress.gov/brbk/html/ebtxr70.html].
CRS Report RL31177, Extending the Internet Tax Moratorium and Related Issues,
by Nonna A. Noto. (Addresses issues raised in the 107th Congress.)
CRS Report RL31252, Internet Commerce and State Sales and Use Taxes, by Steven
Maguire.
CRS Report RL31158, Internet Tax Bills in the 107th Congress: A Brief Comparison,
by Nonna A. Noto.

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