New Tangles in the E-Tax Thicket

Even as an Internet sales tax agreement is being hammered out, some parties want to bring income tax issues onto the table

By Howard Gleckman

For two months now, key U.S. senators have been haggling over the details of compromise legislation that would allow states to tax sales on the Internet. And for two months, the deal has been hung up on an issue that has nothing whatever to do with e-taxes.

The latest twist in the Internet-tax soap opera? A dispute over whether Washington should limit the ability of states to tax the income of companies that operate in their jurisdictions. In recent years, business has battled states over their authority to levy income taxes, franchise taxes, and similar business-activity taxes inside their boundaries.

The problem of business-activity taxes is an important one. But this squabble should be kept out of the flap over taxing the Net. Asking Congress to resolve both issues at the same time is like adding one more layer to a tottering, multitiered wedding cake: It may be just enough to pull the whole thing down. And that, a skeptic might suggest, may be just what some business groups want.


  Of course, the dispute was always about more than just Internet taxes. State and local governments are more interested in collecting taxes on mail-order sales, which remain a far greater source of revenue than e-commerce. But the Supreme Court has barred them from requiring out-of-state sellers to collect such taxes. It has ruled that unless a company has a physical presence -- such as a store or warehouse -- in a state, it cannot be required to collect sales taxes for that jurisdiction.

At the moment, the e-tax world is fixated on whether Senators Ron Wyden (D-Ore.), Byron Dorgan (D-N.D.), John McCain (R-Ariz.), and Commerce Committee Chairman Ernest Hollings (D-S.C.) can nail down a compromise on sales taxes. The proposed deal would let states require retailers to collect taxes on goods sold on the Web or through mail-order catalogs once 20 to 25 states agree to dramatically simplify their sales-tax systems (see BW Online, 5/1/01, "A Break in the E-Tax Impasse?").

Even if the senators can close their deal, it won't settle the conflict over business-activity taxes. And there'll be plenty more opportunities for it to be brought up. An extension of the current Net-tax moratorium, which must be approved before the freeze expires in October, will still have to move through at least four congressional committees, as well as the full House and Senate. And as the various bills work their way through Congress, the business-activity tax controversy is certain to pop up again.


  Just as states have used the e-tax debate as their Trojan Horse, so have business groups. Financial firms, for instance, have little interest in sales taxes, which are rarely charged on bank services or stock trades. But they are very concerned about having to pay state income taxes. "This is a big issue for us," says Mark Nebergall, a Washington lobbyist who represents a group of high-tech companies.

The heart of the dispute is similar to the question that has dogged e-taxes: When does a business have enough of a presence in a state that it becomes subject to that state's tax laws? Business groups fear the proverbial slippery slope: Today, a state decides a company must collect sales taxes owed by its customers. Tomorrow, it says the company must pay taxes on its own income.

Businesses that operate in several states have a legitimate fear that they'll get taxed many times on the same profits. And some of these battles are already in the courts. One closely watched suit involves a dispute between the State of Tennessee and AOL Time Warner. The massive media conglomerate has argued, so far successfully, that it has no business presence in the state, even though it has tens of thousands of customers there.


  Some businesses, particularly tech companies and financial-services firms, see the flap over Internet taxes as an opportunity to put the brakes on states that are overly aggressive taxers. Others have a somewhat different agenda: They see the issue as a way to scuttle any agreement on Internet sales taxes.

Unfortunately, the more these issues get mixed together, the greater the odds that none of them will be resolved before the e-tax moratorium expires in October. That may not bother some tech companies, but it would give the current crazy-quilt sales tax system still another reprieve. And that would be bad for both business and government.

Gleckman is a a senior correspondent in BusinessWeek's Washington bureau. Follow his views every Tuesday in Washington Watch, only on BW Online

Edited by Douglas Harbrecht

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