ISC tax issues.

• Author: Moore, Philip E.
• Position: Internet sales company

Tax issues should be considered in the formation, application and operation of an Internet sales company (ISC), and e-commerce in general. Many issues will be based on the specific facts and circumstances involved in the use and operation of a proposed company; however, there are certain issues generally applicable to the planning stages of a special-purpose entity to facilitate direct-shipment sales of tangible products to customers in other states and/or foreign countries by a business.

Issues in Formation/Entity Selection

The selection of' the type (and location) of entity to be used as an ISC is perhaps the most important consideration, from both a Federal and state tax perspective.

Generally, an ISC's purpose is to facilitate sales in interstate commerce with a minimum of physical presence or activity in the destination state. Accordingly, state tax concerns tend to overshadow Federal concerns in the selection of the type and form of entity. For this reason alone, the corporate form of operation tends to provide greater flexibility and potential state tax savings.

Benefits of the corporate form of operation include the availability of allocation and apportionment rules and the ultimate burden of state tax at the entity (as opposed to individual, partner or member) level. (A tiered structure with corporate partners or members could provide similar benefit, but nexus issues on behalf of corporate partners can affect the overall benefit of the corporate partner/member form.) In addition, a corporate ISC may also avail itself of favorable "separate return" states, as well as apportionment factor planning in unitary states such as California.

With the availability and popularity of entity alternatives under the check-the-box regulations and in the Small Business Job Protection Act of 1996 provisions affecting qualified subchapter S subsidiaries, passthrough entities have become the choice in many corporate structure plans. In many cases, it is possible to arrange a business structure to take advantage of the benefits of passthrough treatment at the state level, but these situations tend to be more complex than their C corporation counterparts. If passthrough entities are to be considered in an ISC business structure, the expected states of sales and operations must be reviewed, as well as which existing entities and/or parties will be partners/members in the passthrough [SC.

Because of the inherent flexibility in forming and operating a...