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Feds and States Look For New Ways To Tax The Internet

By Martin H. Bosworth
ConsumerAffairs.com

April 13, 2006
Think you're saving money by ordering goodies from Amazon and downloading music from iTunes for 99 cents? Well, you are. But a wave of actions from state and federal governments may soon put an end to the free ride we've all enjoyed.

New plans to tax online purchases, and more aggressive enforcement of tax collections, may shift the way people shop on the Web.

A number of states and the District of Columbia are already levying "use taxes" on digital media downloads, according to a report from CNET News.

What was once a fringe operation for the tech savvy has boomed into a $100 billion-plus market from downloads of movies, music, e-books, and video, and many revenue-hungry states are looking to get a piece of the action.

"Use taxes" are a different form of sales tax, levied to recoup revenue lost when a resident of one state purchases an item in another state, but uses it in their home state. Essentially, it is a "phantom tax," wherein the buyer is potentially taxed twice for the same item.

Taxpayers who live in states with "use taxes" either pay the money due at the time of purchase, or on April 15th, when taxes are due. Failure to provide the exact amount of money to cover the tax can lead to penalties and audits.

The push to levy taxes on Internet purchases is part of a multi-state initiative called the Streamlined Sales Tax Project (SSTP). The SSTP is designed to create uniform, streamlined sales and use tax codes, part of which involves agreement among the participating states to collect taxes from out-of-state sales.

Forty-three states and the District of Columbia participate in the SSTP. The ultimate aim of the project is to convince Congress to pass national law endorsing the ability of states to tax purchases made in other states.

A 1992 Supreme Court case, Quill vs. North Dakota, held that without federal law governing the process, states taxing each other "remotely" on out-of-state purchases violated the interstate commerce clause of the Constitution.

Never passing up an opportunity to squeeze taxpayers, several Senators have proposed new legislation to create that exact federal law.

One bill, the "Sales Tax Fairness and Simplification Act," would allow participating states to impose remote sales taxes on business with gross profits of $5 million and higher. The bill, introduced in Dec. 2005, is currently awaiting discussion in the Senate Finance Committee.

Sen. Mike Enzi (R-WY), the bill's sponsor, has been a strong advocate of levying taxes on Internet purchases, claiming that unless that lost revenue is recouped, states will have to impose higher property or income taxes to compensate.

Putting The Pinch On PayPal

The IRS is also looking at new ways to enforce federal tax collection from the Web. As part of an ongoing effort to collect information on shifting of money offshore to avoid paying taxes, the IRS recently won approval to get the records of online payment merchant PayPal.

PayPal, the chief transaction arm of online auction giant eBay, processes billions of dollars in online payments, moving $27.5 billion last year. The IRS and the Department of Justice believe that some of those billions may belong to tax cheats who are moving their money online to offshore tax havens.

Although the IRS has already shaken down payment processors and credit card companies such as MasterCard and Visa in its probe, this is the first time it has sought the records of a "pure" Internet company.

PayPal had no immediate response to the court ruling.

Privacy advocates and taxpayers are concerned not only about potential damage to the security of PayPal customer information, but that this may be only the first step in a more aggressive campaign to get tax money from Internet businesses, be they online merchants, resellers, or discount stores.

Tax attorney Martin Press told the Florida Sun-Sentinel "this may be the first step of the IRS going after people who use the Internet to sell stuff."

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