Today's tax environment is very favorable to remote sellers and is detrimental to state tax collectors. However, this will not last forever. Over the next several years a balance will be struck, where states will be granted additional powers to tax Internet-based and other remote sellers. In this series of articles, I will briefly look at today's tax environment in the United States for Internet-based and other remote sellers, and speculate about what is to come.

Over the next several years, representatives of state governments and the private sector will engage in a political struggle to determine how Internet-based and other remote sellers will be taxed. There is little an individual electronic enterprise can do to affect the outcome of this struggle. However, companies should plan, now, for a tax environment less favorable than that which exists today.

Questions must be addressed now, as companies are planning to invest resources in online stores and online services. For instance, what would be the impact on forecast product sales if all sales were subject to sales and use tax? What would be the cost of tax compliance where a company is subject to sales tax and state income tax in all 50 states?

Product Sales

• How things are now. The online environment for product sales is very good. With relatively little cost, vendors can gain access to national and international markets. In the United States, these vendors enjoy a competitive advantage over Main Street retailers, in that they can avoid having to collect sales tax in states where there is no nexus (i.e., there is no physical presence). Take, for example, Amazon.com. This organization sells books all over the country, but collects sales tax in only a few states.

  The current state of affairs results in small companies that engage in multi-state commerce with little concern for taxation outside their home states. Because they are generally liable to collect sales and use tax only in their home states, there is little administrative difficulty in tax compliance.

  Of course, there are many ways that a vendor can have nexus in another state, resulting in a sales tax collection responsibility. For instance, the use of a Web server in another state, trade show attendance in another state, agents or employees in another state, plus a variety of other circumstances can all result in nexus for sales and use tax. However, a taxpayer that is aware of the nexus traps can easily avoid them

  Depending on where a company is organized, the company can also reduce its state income tax by selling outside its home state. From a state income tax point of view, a company's main concern is to maximize the benefits of state income tax reduction when selling outside the home state.

• What the future may hold. Currently, Internet-based product sales are relatively small, and have little impact on taxes. However, Internet-based sales are expected to rise rapidly, and state tax revenues will likely fall in direct relation to increases in these sales. The current tax rules, already unacceptable to the states, will become untenable.

  Since the Quill Corp. v. North Dakota decision in 1992, Congress has had the authority to grant states the power to require remote vendors to collect sales and use tax on all sales. Bills have been introduced in Congress that would grant the states this power. All have been defeated. The recently enacted Internet Tax Freedom Act (ITFA) is the states' best hope for a change in their favor.

  The ITFA created the Advisory Commission on Electronic Commerce, which is mandated to look at all aspects of e-commerce taxation, including the question of granting the states the power to collect sales and use tax from remote sellers. The Commission is supposed to report its findings and recommendations to Congress in the spring of 2000.

  Given the detrimental effect that e-commerce may have on state tax revenues, it seems likely that the Commission will recommend, and that Congress will grant, some form of power to tax remote vendors. There are many options, from power to tax all remote transactions, to power to collect tax from vendors only when certain sales dollar thresholds are met. What this means is that vendors will lose one of the big competitive advantages that is driving increases in Internet-based sales.

  Until Congress acts, businesses can still enjoy the relatively tax-free environment of the Internet. However, businesses, and their advisers, must plan for the future. A long-term strategy that assumes that remote sales will be free of sales tax is foolish. As it showed in its 1986 tax act, Congress is not adverse to doing substantial harm to an industry that it sees as having unwarranted tax advantages.

  The 1986 tax act removed almost all of the tax benefits of "tax shelters," which it termed "passive activities." The removal of the benefits of tax shelters contributed in large part to massive commercial real estate losses, a virtual shut-down of commercial real estate lending, and the collapse of many savings and loans.

  E-commerce companies and their advisers must take into account a future in which sales and use tax must be collected. In planning for the future they must look at the possible loss of sales revenues. For instance, if Amazon had to collect sales and use tax on all sales, how would its sales be affected?

  In December 1998, Austan Goolsbee of the University of Chicago's Graduate School of Business published a study on the effect of sales tax on e-commerce, "In a World Without Borders: The Impact of Taxes on Internet Commerce." According to the report, "people who live in locations with high sales taxes are significantly more likely to buy things over the Internet."

  The paper concluded that, "The magnitudes in the paper suggest that to apply existing sales taxes to Internet commerce would reduce the number of online buyers by 25 percent and spending by more than 30 percent with some specifications suggesting even larger effects."

  E-commerce companies and their advisers must also look at building into their Web sites the ability to calculate and collect sales and use tax based on the locations of buyers. By some estimates, there are 30,000 tax jurisdictions in the United States alone. Software that handles the job of calculating and reporting tax exists, but it is expensive.

  Sales and use tax in the United States is the big issue, and may be the only issue decided by the Advisory Commission on Electronic Commerce. However, taxation of foreign sales will also be looked at, as will state income tax issues. These are two areas that need to be monitored.

Professional Services

• How things are now. Most professional services are delivered locally. Web sites used by sellers of personal services are used mainly as online brochures. Even where a personal service provider is found via the Internet, the actual service tends to be local. For instance, legal, accounting and medical services are provided locally. These types of services require a certain level of trust between the provider and the client that is difficult to achieve when the two are located in different states or countries and the only means of communication is by telephone, email or fax.

  Generally, where professional services are concerned, once primary communication is established, the Internet has no further use, except for delivering email. Accordingly, the Internet presents no special issues for providers of professional services.

  Currently, professional services are subject to sales and use tax in a number of states if the professional has nexus in the state. As discussed above, nexus usually requires some form of physical contact. State income tax is imposed based on where the services are performed.

• What the future may hold. In the future, increased bandwidth and modem speeds will allow every PC to be a teleconferencing device. PCs will include digital cameras as standard equipment. IP telephony (i.e., long-distance telephone service via the Internet) will be expanded to transmit both voice and image. This will lead directly to an expansion of long-distance professional services. When providers and clients can see each other, there may be a large increase in long-distance professional relationships, where the means of communication is the Internet.

  For instance, certain types of legal services, where individuals are currently using do-it-yourself books, could be handled via the Internet. Tax preparers, located in low-wage countries such as Russia and India, could provide low-cost services to customers all over the world. Specialists of all kinds could be called on to consult, via the Internet, throughout the world.

  All of these things can take place now, however, many people are uncomfortable with merely a voice on a telephone and will pay extra for personal contact. The advent of desktop teleconferencing will add just enough personal contact to make more people comfortable with long-distance advice, counsel and services.

  Under current rules, professionals that provide services to customers in other states and other countries, without going to customer locations, are generally unconcerned with taxes at customer locations. This could change fast.

  For instance, tax preparers in states that impose a sales tax on these services could face stiff competition from Internet-based services provided from another state. There could arise a loud clamor for new nexus rules that would allow states to impose sales tax on remote providers of services. The Advisory Commission on Electronic Commerce may recommend broad new nexus rules that would allow states to tax out-of-state providers.

  State income tax rules already impose tax based on where services are performed. There seems to be little need for changes in this area.

Planning Today for a Digital Tomorrow
For companies their advisers, the message of this article is: The only thing certain is change. It is unlikely that today's tax environment, which favors e-commerce, will remain for long. Especially in state sales and use tax, the potential for lost tax revenues is too great. In planning, assume that things will change. For instance, business plans and investments should be evaluated on the basis that all transactions will be subject to sales and use tax.

How would forecast sales be affected if sales are subject to sales tax in all 50 states? How would forecasted cash flows be affected if the company is subject to state income tax in all 50 states? For small vendors, is a business plan viable when the company is subject to tax in all 50 states? Can the company afford the cost of tax compliance?

Tax advisers and e-commerce consultants, who concern themselves primarily with local tax issues, must prepare for a new world, where taxation will be vastly more complicated.