What Is the Internet Tax Moratorium?
Explore the federal legislation that shapes how the internet is taxed, clarifying the distinction between service access and online sales.
The Internet tax moratorium is a federal law, formally known as the Internet Tax Freedom Act (ITFA), first enacted in 1998. Its purpose was to foster the growth of the internet by preventing state and local governments from levying new taxes on it. The law established a national policy against certain types of taxes that could hinder the commercial and educational potential of the internet. This moratorium was designed to prevent a complex patchwork of state and local taxes from slowing the expansion of electronic commerce and online services.
Prohibited Taxes on Internet Access
The Internet Tax Freedom Act prohibits two main categories of taxation by state and local governments. The first is on taxes on internet access itself. This means a monthly bill from an Internet Service Provider (ISP) for services like DSL, cable, or fiber optic connections cannot have a line item for a state or city “internet access tax.” The law defines internet access broadly as a service that enables users to connect to the internet, and this ban includes incidental services like email accounts when part of the overall service package.
The second prohibition is against “multiple or discriminatory taxes on electronic commerce.” A multiple tax would involve taxing a single online transaction by more than one state. A discriminatory tax is one that treats online purchases differently from transactions in a physical store, for instance, by imposing a special tax solely on goods bought over the internet.
Permissible Taxes Related to the Internet
The law does not create a general tax-free zone for all online activities. State and local governments are still permitted to impose and collect general sales and use taxes on goods and services that are purchased online.
The ability for states to collect these sales taxes was significantly clarified by the Supreme Court’s 2018 decision in South Dakota v. Wayfair. This ruling overturned the previous “physical presence” standard, which required a business to have a physical location in a state to be obligated to collect sales tax there. Following this decision, states can now require online retailers to collect and remit sales taxes on purchases made by residents of that state, even if the seller has no physical stores or warehouses within its borders. This ensures that online retailers are generally subject to the same sales tax requirements as brick-and-mortar stores.
The Grandfather Clause and Its Expiration
When the Internet Tax Freedom Act was first passed in 1998, it included an exception known as the “grandfather clause.” This provision allowed a small number of states that had already enacted and were enforcing taxes on internet access before October 1, 1998, to continue collecting them. This exception was included to avoid disrupting the existing revenue streams of these specific states. Initially, about a dozen states qualified for this exemption, but over time, several of them voluntarily eliminated their internet access taxes.
The grandfather clause was not intended to be a permanent exception. As part of the legislation that made the internet tax ban permanent, a final expiration date was set for the grandfather clause. This provision officially ended on June 30, 2020, at which point the few remaining states were no longer permitted to tax internet access charges.
Transition to a Permanent Ban
For nearly two decades, the Internet Tax Freedom Act was a temporary measure that required periodic extensions from Congress to remain in effect. This created uncertainty for both consumers and the telecommunications industry, as the protections could have lapsed without legislative action. The law was extended multiple times between its initial passage in 1998 and 2015. This cycle of temporary extensions ended on February 24, 2016, with the signing of the Trade Facilitation and Trade Enforcement Act of 2015. A provision within this larger trade bill was the Permanent Internet Tax Freedom Act (PITFA), which made the moratorium on internet access taxes and discriminatory e-commerce taxes a permanent fixture of federal law.