Order Code RS20577
Updated January 10, 2001
CRS Report for Congress
Received through the CRS Web
State Sales Taxation of Internet Transactions
John R. Luckey
American Law Division
There are at least two common misconceptions in the area of State taxation of
Internet transactions. Contrary to popular opinion, (1) States do have the power to
impose a sales tax on sales that are accomplished via the Internet even after the
enactment of the Internet Tax Freedom Act in 1998 and (2) States do have the power
to tax transactions where the seller is located outside of the State and has no real
connection with the State. The Internet Tax Freedom Act placed a three year
moratorium only on imposition of new taxes on “Internet access services” (existing taxes
on access services were grandfathered) or any “multiple or discriminatory taxes on
electronic commerce” by State or local governments, not on application of a general
sales tax to such transactions. In the 106thCongress, the House passed H.R. 3709 which
would have extended the moratorium for five years and repealed the grandfather
provision for existing taxes on Internet access services. The Senate took no action on
Under current law a State may tax a transaction if there is some connection of the
transaction to the State. Thus if the seller or the buyer is located in the State, the
transaction may be subject to the State’s sales tax. The important question in the out-ofState seller context is not the State’s power to tax the transaction, but rather does the
out-of-State seller have sufficient nexus to the State so that the State can require the
out-of-State seller to collect the sales tax from the purchaser. H.R. 3709 did not address
the nexus issue.
This report briefly examines two common misconceptions in the area of State
taxation of Internet transactions. These misconceptions are: (1) the Internet Tax Freedom
Act of 19981 placed a moratorium on a State’s power to impose a sales tax on sales that
are accomplished via the Internet; and (2) States may not tax transactions where the seller
is located outside of the State and has no real connection to the State.
The Internet Tax Freedom Act comprises Titles XI and XII of Division C of the Omnibus
Consolidated and Emergency Supplemental Appropriations Act of 1999, P.L. 105-277, 112 Stat.
Congressional Research Service ˜ The Library of Congress
The Internet Tax Freedom Act placed a three year moratorium on imposition of new
taxes on “Internet access services” or any “multiple or discriminatory taxes on electronic
commerce” by State or local governments.2 In other words, States may not (during the
moratorium period) enact a sales tax which applies only to Internet transactions or taxes
Internet transactions at a different rate than other transactions. It may apply a sales tax
which is imposed on sales equally without regard to the medium (face to face, mail order,
or internet). The Act specifically states that:
.....nothing in this title shall be construed to modify, impair, or supersede, or authorize
the modification, impairment, or superseding of, any State or local law pertaining to
taxation that is otherwise permissible by or under the Constitution of the United States
or other Federal law and in effect on the date of enactment of this Act.3
In the 106th Congress, The House passed H.R. 3709, which would have extended the
moratorium for five years and repealed the exemption for existing taxes on Internet access
A State may tax a transaction if there is some connection of the transaction to the
state. Thus if the seller or the buyer is located in the State, the transaction may be subject
to the sales tax. The important question in the out of State seller context is not the State’s
power to tax the transaction, but rather can the State require the out of State seller to
collect the sales tax from the purchaser.5
The Due Process6 and Commerce7 Clauses of the United States Constitution limit a
State from imposing tax liability or collection responsibilities on a business concern unless
there is a substantial nexus or in-state contact established with the State. There is
currently no statutory authority and scant case law on the subject of nexus and the internet,
but the Supreme Court has given considerable guidance in the analogous area of taxation
Id. at § 1101(a). The moratorium expires on October 21, 2001.
Id. at § 1101(b).
H.R. 3709 was reported to the House on May 4, 2000 (H.Rept. 106-609) and passed the
House on May 10, 2000 (146 CONG. REC. H2821 (daily ed. May 10, 2000)(record vote no.
Several States impose a duty on the in-State buyer to report the purchase from an out-of-State
seller and remit the sales tax. Needless to say, compliance with these requirements is very low.
U.S. Const. amend. XIV § 1.
U.S. Const. art. I § 8, cl.3.
of mail order sales. The two major Supreme Court decisions in this area are National
Bellas Hess, Inc. v. Illinois Department of Revenue,8 and Quill Corp. v. North Dakota.9
In National Bellas Hess the Supreme Court held that the State of Illinois could not
require an out of State mail order sales company to collect a use tax from Illinois
customers. Bellas Hess’s only contact with the State was via the mails or common
carriers. This contact was found to be insufficient to establish nexus under either the Due
Process or Commerce Clause. The Court utilized a physical presence standard for nexus
for both of these clauses.10
In the twenty-five years between Bellas Hess and Quill the Supreme Court had
clarified the Commerce Clause’s four part test in Complete Auto Transit, Inc. v. Brady.11
For a state tax to be applied to an activity there must be substantial nexus with the taxing
State. The tax must be fairly apportioned. It must not discriminate against interstate
commerce. The tax must be fairly related to the services provided by the State.12
This clarification became even more significant in the mail-order sales area in the
Quill decision. In Quill the Court, in a case factually similar to Bellas Hess, dropped the
physical presence test for nexus under the Due Process Clause, requiring only that the
seller’s efforts be “purposefully directed toward the residents of the taxing State.”13
Therefore the Due Process Clause was no longer an impediment to requiring tax collection
by the out of State seller. However, the physical presence standard or substantial nexus
requirement of the Commerce Clause was reaffirmed.14 Therefore the practical out come
of the case was the same as Bellas Hess. The State could not force the seller to collect
the tax absent a substantial nexus.
The removal of the Due Process Clause as a road block did open a door for
Congress, under its commerce powers, to legislatively empower the States to require the
collection of these taxes. The Supreme Court, in Quill, specifically invited Congress to
act in this area. To date, Congress has chosen not to enact legislation in this area.
386 U.S. 753 (1967).
504 U.S. 298 (1992).
386 U.S. 753 (1967). Generally, the Due Process Clause relates to the fairness of the tax burden
and whether a business has minimum contacts with the taxing jurisdiction. The Commerce Clause
is concerned with the effect of the tax on interstate commerce. Walter Hellerstein, Supreme Court
Says No State Use Tax Imposed on Mail-order Sellers...for Now, 77 J. Tax’n 120, 120 (Aug.
430 U.S. 274 (1977).
Id. at 279.
Quill at 312.
Id. at 317.
Other CRS Products
CRS Report RL30667, Internet Tax Legislation: Distinguishing Issues, by Nonna A.
CRS Report RL30431, Internet Transactions and the Sales Tax, by Steve Maguire.
CRS Report RL30412, Internet Taxation: Bills in the 106th Congress, by Nonna A. Noto.
CRS Report 95-655 C, Taxation of Mail Order Sales: A Fact Sheet, by Arnold Solomon.
( May 26, 1995).
CRS Report 92-487A, Quill v. North Dakota: The Mail Order Tax Case, by Thomas B.
Ripy. (June 8, 1992).