Debate Continues on Taxes in the Digital World

Online buyers who have grown used to making purchases without paying sales tax may soon find that their tax-free days are numbered. As traditional tax-collecting retailers cry foul and states look to capture tax revenue that they say they are due, lawmakers are once again floating plans designed to level the playing field and generate much-needed cash.

Universal Sales Tax for All Online Purchases

One of the most recent moves on the federal level is the introduction of the Main Street Fairness Act (MSFA). The proposal would require consumers to report their online purchases when they file their taxes and remit any sales tax that is due, if the seller has not already done so.

A number of states already have similar laws, but many taxpayers are either unaware of their obligation to pay sales tax, or they simply ignore it. Big ticket items like cars and boats are hard to avoid because the tax is due at the time of registration, but routine purchases of small items may currently escape the notice of state authorities.

In introducing the MSFA, Senator Richard Durbin (D-Ill.) said that in 2012, states could lose as much as $24 billion in uncollected state and local taxes on Internet and catalog sales. He said Illinois alone has lost $153 million each year since 2005, due to a lack of sales tax on online sales.

Durbin added that the new tax attempts to "level the playing field" between online giants and smaller businesses by exempting some small retailers from having to collect sales tax, even in states where taxes are due. However, the bill does not clearly define a small business.

Fair Treatment of Digital Goods and Services

In May, bills were introduced in both houses of Congress to prohibit the imposition of multiple or discriminatory sales or use taxes on purchases of digital goods or services. More than 20 states already collect taxes on digital goods such as music files, e-books and software.

Under the Digital Goods and Services Tax Fairness Act of 2011, states could not collect a higher tax on printed books, for example, than on e-books. The goal is to prevent double taxation and to prevent digital goods and services from having an unfair competitive advantage over their tangible counterparts.

Taxes on the Cloud

Transactions for cloud computing services are also facing close scrutiny by states. Some are saying cloud-related transactions, such as access to shared software and digital storage resources, should be subject to tax, while others are continuing to study the issue.

Cloud computing models generally allow businesses and consumers to pay a fee to use software that is housed on a remote server. The question that arises is whether this access to the software is a service (which is not taxed by the majority of states) or a tangible personal property purchase that would be subject to tax (like the purchase of off-the-shelf software).

A handful of states have issued rulings on how cloud computing purchases should be addressed, but the majority are still studying the matter and exploring their options.

Billions of dollars in revenue are at stake as worldwide cloud computing sales are predicted to reach $150 billion by 2012, according to Gartner Inc.

When most sales and use tax laws were originally written, no one could have envisioned how everyday business and personal transactions are migrating into the digital realm. Economic pressures and the fast pace of technology change are combining to make digital commerce a tax trend to watch.

Contact our tax professionals for more on state and local tax issues.

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