Inadvertently establishing state taxing jurisdiction through the Internet.

• Author: Nathanson, Michael J.

Within only the past two years, the global business community has unreservedly embraced the Internet as a seemingly boundless, yet relatively efficient, means for conducting business without regard for traditional geopolitical constraints. The speed, pervasiveness and certainty of this phenomenon are matched only by the enthusiasm and conviction that so plentifully fuel it. Yet, businesses that have embraced (or are preparing to embrace) the Internet might do well to pause and consider some of the tax implications--particularly the state tax implications--of conducting business through the Internet.

Most obvious among these state tax implications are the potential for multistate sales and use taxation of goods and services sold or provided through the Internet, and the potential for multistate income taxation of earnings derived through the Internet. The unexplored issues that inevitably arise when considering these implications, however, are too numerous to be fully addressed here; this item will address a specific (but highly fundamental) issue: the potential for businesses operating through the Internet to inadvertently subject themselves to the taxing jurisdiction of states in which they do not otherwise operate (and were not previously taxable).

Businesses that, for the first time, subject themselves to the taxing jurisdiction of a state--whether inadvertently or intentionally--can expect to suffer several adverse consequences. First, they can expect to become legally obligated to collect and pay the sales and use taxes imposed by that state. Satisfying this obligation generally will be expensive, not only from an administrative perspective, but also (and perhaps, more importantly) from a competitive perspective, as real economic prices inevitably must rise to account for the imposition of these taxes. Second, they can expect that a portion of their total income will be subjected to multistate income taxation. Generally, the portion that will be taxed by a particular state will be determined under an "apportionment" formula based on One or more of the following factors: (1) percent of total sales in the state, (2) percent of total property in the state and (3) percent of total payroll (i.e., workforce) in the state.

Thus, businesses should consider carefully whether they might adopt certain strategies for using the Internet in ways that will minimize their exposure to taxation by states in which they do not otherwise operate. At the very least, they should be prepared to defend themselves in the event that one or more states assert their taxing jurisdiction over them based solely on their use of the Internet.

Background

It is well settled that, while the states inherently possess vast power to impose taxes on businesses operating m or deriving profits from within their borders, this power is subject to clearly defined limits under the Commerce Clause and the Due Process Clause...