Overview
A March 3, 2020 US Supreme Court decision[1] applies principles of federal preemption of state legislation and – while not a tax case – adds weight to arguments that taxes proposed in Maryland,[2] Nebraska,[3] and New York state[4] are barred by the Internet Tax Freedom Act[5] (ITFA).[6]
In 1998, Congress exercised its power under the Supremacy Clause[7] to enact a temporary version of ITFA and encourage growth of the Internet without it being impeded by a mass of subnational taxes. In 2016, Congress and President Obama made ITFA permanent. Throughout its existence, ITFA has provided and continues to provide that
"No State or political subdivision thereof may impose any of the following taxes:
(1) Taxes on Internet access.
(2) Multiple or discriminatory taxes on electronic commerce."[8]
2020 State Legislation Testing ITFA
In the two decades since ITFA’s enactment, the states have (mostly) avoided challenging this federal shield protecting electronic commerce.[9] That has now changed. The states, undoubtedly emboldened by their successful direct challenge to 50 years of federal case law in Wayfair,[10] have launched a taxing offensive against ITFA and electronic commerce. Thus, a mere two months into 2020, three states' legislatures are considering the following legislation:
- Maryland: A 2.5% to 10% tax on gross revenues derived from digital advertising services in the state.
- Nebraska: An expansion of the state’s sales and use tax bases to apply to "digital advertisements," defined as "an advertising message delivered over the Internet that markets or promotes a particular good, service, or political candidate or message."
- New York state: A five percent franchise tax on the gross income of "every corporation which derives income from the data individuals of this state share with such corporations." We anticipate significant revisions to the language and reach of this bill, potentially including a limitation to data derived through electronic commerce.
We expect to see more such bills introduced this year and further into the future.
After a taxpayer demonstrates that ITFA applies to a state law taxing electronic commerce and argues that ITFA is violated by that state law, the state must demonstrate that the disputed taxation of electronic commerce is nondiscriminatory. Proof of nondiscrimination can involve a showing that electronic commerce and non-electronic commerce are taxed in the same manner or, according to at least one state’s appellate court, by showing that there is no non-electronic commerce that is comparable to the taxed electronic commerce.[11]
It is unlikely that Maryland and Nebraska's taxes – if enacted in their current form – will survive challenges in the courts.[12] This is because, unlike the common law,[13] physical presence test in Wayfair that was (a) 50 years old, (b) reconfirmed by the US Supreme Court only once in those 50 years (and even that was due only to the Court’s respect for precedent), and (c) never codified by Congress, ITFA is federal statutory law. Specifically, ITFA was temporarily enacted by Congress in 1998 and was extended and updated four times over the next 16 years[14] before being made permanent in 2016. Thus, Congress has acted on ITFA six times in 18 years, as contrasted to its failure over 50 years to codify the test at issue in Wayfair.
Garcia's Significance
Garcia involved an alleged conflict between:
- a federal law that (i) criminalizes employer's hiring of an alien knowing that the alien is not authorized to work in the United States and (ii) preempts any state or local law imposing sanctions on those who employ unauthorized aliens or recruit unauthorized aliens for employment, and
- a Kansas law that criminalizes the use of another person’s identifying information to commit fraud and receive benefits.
Garcia submitted Kansas tax forms using someone else's social security number to obtain employment and was convicted of identity theft under Kansas law. However, he maintained that federal law preempted Kansas law.
The Court opened its preemption analysis with a discussion of the Supremacy Clause, stating that “If federal law imposes restrictions or confers rights on private actors and a state law confers rights or imposes restrictions that conflict with the federal law, the federal law takes precedence and the state law is preempted."[15] Significantly, all of the Justices concluded that a state's law must yield if federal law "expressly" addresses an area of law in a manner inconsistent with the state law, or if federal law controls an entire subject matter "field" or "conflict." Moreover, all of the Justices agreed that federal preemption can be implied by circumstances surrounding federal law "[I]t has long been established that preemption may also occur by virtue of restrictions or rights that are inferred from statutory law."[16]
Thus, under the Supremacy Clause as interpreted and applied by the Court, there are several analytical avenues to determine whether a state law is preempted by federal law. Each of these avenues is available to taxpayers arguing that ITFA preempts a state tax on electronic commerce.
While a close analysis of the effect of ITFA on the three pending bills would need to be the subject of another article, there is no denying that, even now, ITFA preemption appears to apply to the bills introduced in Maryland and Nebraska. At the moment, New York state's law seems less vulnerable to attack because on its face it appears to apply to all data, whether obtained via electronic commerce or non-electronic commerce; however, the tax might be susceptible to an implied preemption argument. Moreover, changes to the language of the proposed new tax could raise additional ITFA preemption concerns.
Finally, when other states consider bills attempting to tax electronic commerce, taxpayers should bear in mind the strong preemption arguments that are likely to be available.
[1] Kansas v. Garcia, 589 U.S. ___ (No. 17-834).
[2] Maryland Senate Bill 2.
[3] Nebraska Legislative Bill 989.
[4] New York State Assembly Bill 9112.
[5] 47 U.S.C. §151 (note) (ITFA §§1100 through 1109).
[6] Separate from any ITFA preemption argument, a state tax on electronic commerce might be subject to challenges for a variety of reasons including due process violations, violations of the Commerce Clause, violations of a state's constitution, and many other types of violations.
[7] US Constitution, Art. VI, cl. 2. Congress's authority for enaction of ITFA and its preemption of discriminatory subnational taxation of electronic commerce is further derived under the US Constitution's Commerce Clause (Art. I, §8, cl. 3).
[8] ITFA §1101.
[9] In one of the few decisions in this area, the Illinois Supreme Court held that state's "click-through" nexus provision void as violative of ITFA and the US Constitution's Supremacy Clause. Performance Marketing Association, Inc. v. Hamer, 375 Ill. Dec. 762 (Oct. 18, 2013). See also Labell v. City of Chicago, 2019 Il. App. 181379 (Nov. 21, 2019) (holding that a city tax on video streaming services was not discriminatory because there were no comparable services that did not involve electronic commerce; the court therefore concluded that ITFA was not violated), (appealed to Ill.S.Ct. Dec. 19, 2019, case no. 125581).
[10] South Dakota v. Wayfair, Inc., 585 U.S. __ (2018).
[11] Labell, supra at ¶65, stating that the taxpayers/plaintiffs' "failure to cite to any authority that live cultural performances are similar to streaming services in their ITFA argument…Had we agreed with plaintiffs and come to the conclusion that streaming services were the same as automatic amusement devices and live cultural performances, a discussion of the potential discrimination against electronic commerce under [ITFA] would be warranted. We, however, came to the opposite conclusion. Accordingly, we conclude that the ITFA does not operate to invalidate the amusement tax on streaming services."
[12] Tellingly, in advising a Maryland senator as to S.B. 2's constitutionality, Maryland's attorney general could conclude only that "I do not think that Senate Bill is clearly unconstitutional." Opinion of the Attorney General of Maryland (February 7, 2020). It is questionable whether Maryland's attorney general could have reached even that low threshold if her analysis had included the US Constitution's Supremacy Clause (Art. VI, cl. 2), as the Court did last week in evaluating federal preemption in Garcia.
[13] That is, case law rather than statutory law.
[14] In 2001, 2004, 2007, and 2014.
[15] Garcia, slip op. at 9 (internal quotation marks and citation omitted).
[16] Id. Discussion of the Justices' opinions regarding Mr. Garcia's alien/identity theft circumstances is beyond the scope of this state tax article. We observe, however, that the Court dismissed Garcia's "express" preemption argument by noting that the federal preemption provision applies to employers (not employees), id. at 10. It also rejected his remaining preemption arguments as applying the wrong federal law, id. at 17, and by noting that criminal law enforcement is primarily a responsibility of the states. Id. at 19.
The four dissenting Justices interpreted "implied" preemption more broadly than did the majority. According to the dissent, implied preemption must consider "not just what a state law says, but what it does. For this reason, even generally applicable and facially neutral state laws may be preempted when applied in a particular factual context in a particular way." Id., dissent, slip op. at 5. As applied to ITFA, the dissent's analysis might be important if a state tax appears to be neutral in its treatment of electronic commerce and non-electronic commerce but, in operation, discriminates against electronic commerce.