From the SIP Trunking Experts

December 17, 2015

A Permanent Internet Tax Freedom Act May Shield Your Revenue, But Not Completely

By Special Guest
Jonathan S. Marashlian and Alex Schneider


For the second time this year, the U.S. House of Representatives passed legislation that would make permanent the law that shields “Internet Access” from state tax liability, called the Internet Tax Freedom Act (“ITFA” or “Act”).  The Senate will now debate the merits of the legislation, which is tied to a larger customs bill.

Observers have heralded the bill, but not always for the right reasons.  Some confuse the legislation with a ban on an Internet sales tax, while others hope to shield their revenue by passing off their hybrid Internet services as “Internet Access.”  Still others believe that Voice over Internet Protocol services (“VoIP”) are not subject to state and local taxation because the voice service requires the Internet.  These myths prevail even as Congress and the courts have chipped away at the coverage of the ITFA.

In truth, the communications industry, including VoIP providers, is one of the most heavily taxed industries in the United States. State and local governments have almost uniformly applied sales taxes, communications excise taxes, and gross receipts taxes to VoIP services.  And states continue to battle to protect revenues, and as more and more telecommunications services run over Internet Protocol rather than legacy PSTN networks, governments will continue to press their claims to communications revenues, taking the issue to court if necessary.

Coverage of the ITFA

The ITFA was introduced in the 1990s to stop a growing trend of governments taxing access to the Internet using metrics such as bandwidth consumed or emails sent.  Congress specifically exempted “Internet Access” from taxation.  This includes services that enable users to connect to the Internet to access content, information or other services, as well as Internet services such as e-mail, instant messaging, voice- and video-capable e-mail and messaging, video clips, and storage. 

The savings are indeed significant.  “If Congress fails to continue the ban on taxes on Internet access, consumers could end up paying more than $16.4 billion annually,” Congressman Tom Cole said in support of the legislation.

But the ITFA does not cover every online service.  For a time, the ITFA exempted VoIP services, but Congress changed the law in 2007 to exclude voice, audio or video programming utilizing Internet protocol for which there is a charge.  The House Committee on the Judiciary admitted that it was changing the rules on taxing VoIP “so that States and localities will be free to tax those services.”

State and local governments have taken advantage of the opportunity to tax VoIP services, despite outdated laws that reference legacy telephone networks.  Some states have explicitly incorporated VoIP into their definitions of communications services.  Florida, for instance, amended its Communications Services Tax statute to apply to services “without regard to whether such service is referred to as voice-over-Internet-protocol services.” 

Other states have used creative legal interpretation to read VoIP regulation into the broad language of their existing tax laws.  New York determined that even though its law defining “telecommunications services” for the purpose of an excise tax used words like “telegraph,” “paging” and “dial tone,” the statutory language nonetheless applies to VoIP services.  “Both VoIP and Wireless VoIP involve the ‘transmission of voice . . . through the use of wire, cable, fiber-optic, laser, microwave, radio wave, satellite or similar media or any combination thereof,’” wrote the Office of Tax Policy Analysis, Technical Services Division.  “Accordingly, such services are within the meaning of telecommunication services for purposes of the telecommunications excise tax.”

Last year, the Iowa Supreme Court announced definitively that Interconnected VoIP services were taxable under the state’s Telegraph and Telephone Company Tax law.  The court reasoned that the original telecom tax law did not require that wiring was built for the purpose of telephony – instead, a cable line used to provide VoIP service became a regulated “telephone line.”  The court also suggested that for subscribers, VoIP versus traditional service was a distinction without a difference.  After all, the court wrote, VoIP customers still use seven- or ten-digit telephone numbers.  In reaching its decision, the Iowa Supreme Court applied the language of the tax statute in a “common-sense manner” rather than assume the legislature intended to capture only technologies that existed when the law was enacted.

An Ongoing Battle for Revenue

States continue to push for more revenue in audits and through the imposition of fees, and the courts are often ready to take their side.  In a recent example, Virginia tax authorities imposed sales and use tax assessments on “Internet reactivation fees” charged by an Internet service provider from 2009 to 2013.  The provider appealed the audit decision assessing a tax on the fees it charged to subscribers for reactivation of services after disconnection, arguing the ITFA applied.  In March 2015, Virginia’s Department of Revenue agreed with the auditors, finding that the ITFA did not prohibit applying communications sales tax to “connectivity charges” not specifically covered in the ITFA.

In fact, courts agree that localities can impose numerous types of fees.  In 2014, an Oregon appeals court sided with the City of Eugene that it could impose a “license fee” on an Internet service provider, finding the fee was not an ITFA prohibited tax.  Courts have similarly agreed that Internet cafes offering cyber gaming can be required to pay a “license tax,” and the re-sale of tickets in an online auction house can be subject to an “amusement tax.”  The ITFA was also found not to prohibit Internet service providers purchasing data transport services from paying sales and use tax.

One feature of the ITFA that state and local governments may use in audits to recover revenue from Internet access providers is the bundling exemption.  When providers offer a bundled package with Internet access and non-Internet access services bundled for a single charge, the entire package may be subject to taxation.  Some Internet access providers avoid scrutiny by keeping “books and records” that breakdown the charges for Internet access and those for other services, while others prefer the safe path of choosing not to bundle their services. 

State governments have fought to protect their revenue sources since the earliest days of the Internet.  In fact, when Congress first codified the ITFA, it helped ensure passage by grandfathering in states that had already taken steps to tax Internet access, including Connecticut, Wisconsin, Iowa, North Dakota, South Dakota, New Mexico, South Carolina, Tennessee, Texas, and Ohio.  State and local governments taking advantage of their ability to collect taxes on traditional Internet Access services take in annual revenues of $500 million.  The latest bill in Congress would end the grandfathered status in June 2020, requiring these states to fill large budget gaps.  As a consequence, we can expect to see not just the formerly grandfathered states, but additional states and local governments, steadily chipping away at the scope of the ITFA’s protections.

Businesses that bundle Internet Access with other products and services will be well-served to analyze the particulars of their offerings to ensure the ITFA unambiguously exempts their offerings from taxes.  Moreover, businesses that wish to use the ITFA to shield their offerings from sales taxes should take pains to package, market, and bill for services in a manner that fits within the strict confines of the ITFA’s very precise language.  If any light is visible between the ITFA’s language and the facts regarding a retail service offering seeking to take advantage of the tax exemption will likely be used by auditors to defeat claimed exemptions. 

While there remain plenty of uncertain and ambiguous tax statutes all around the country, one thing appears certain.  A permanent Internet Tax Freedom Act is not a panacea, and blind reliance on the mantra that “it’s tax free because it’s over the Internet” is just that – blind.  The trend in state and local taxation of VoIP and Internet related services is pointed in one direction – more, not less.  And even with prospects of a permanent federal ban on state taxation of Internet Access services on the horizon, businesses offering Internet Access as part of a bundled retail offering must remain aware of the limitations of the exemption and vigilant to ensure they are taking measures that enhance immunity; to do otherwise could very well come back to haunt you!

Jonathan S. Marashlian is the Managing Partner of Marashlian & Donahue, PLLC, The CommLaw Group ( and co-chair of the firm’s Communications Taxes & Fees Practice. The CommLaw Group has been honored as the Leading Customer Service Law Firm of the Year and Best Communications Law Firm in the U.S. by ACQ Global Awards for three consecutive years. Mr. Marashlian may be reached at (703) 714-1313 or [email protected]  Alex Schneider, George Washington University School of Law -- Class of 2015, assisted in the preparation of this article. 

Disclaimer: This article is intended for informational purposes only and is not for the purpose of providing legal advice. You should not act upon the information in this article without seeking professional counsel.

Edited by Kyle Piscioniere