The Internet, at least up until now, has been the last refuge of commerce untouched by the “Tax Man.”

It all seemed so appropriate that the digital world, created by free-spirited nerds, flourished primarily because the government kept their grubby little hands to themselves.

That is….until now!

One of the issue with taxing the Internet was HOW….how would the state and federal governments track and then collect taxes when most of the present paradigms don’t apply.

Well, it seems that those hurdles may be overcome motivated by the recession and the  pummeling of states' budgets, their governments increasingly want to fill the gaps by collecting taxes on Internet sales, which are growing even as the economy shudders. 

And that is sparking conflict with companies that do business online only and have enjoyed being able to offer sales-tax free shopping. 

One of the most aggressive states, New York, got sued by Amazon.com Inc. over a new requirement that online companies must collect taxes on shipments to New York residents, even if the companies are located elsewhere. New York's governor also wants to tax "Taxman" covers and other songs downloaded from Internet services like iTUNES. 

The amount of money at stake nationwide is unclear; online sales were expected to make up about 8 percent of all retail sales in 2008 and total $204 billion, according to Forrester Research. This is up from $175 billion in 2007. 

Based on that 2008 figure, analysts give of rough estimate that $3 billion could be generated in new revenue for governments if Web retailers had to collect taxes on all sales to consumers. 

Collecting online sales taxes is not as simple as it might sound. A nationwide Internet business faces thousands of tax-collecting jurisdictions - states, counties and cities - and tangled rules about how various products are taxed. 

But leave it up to the IRS to take a complicated situation and make it impossible to understand as is the case with the U.S. Tax Code. 

And of course we have the Supreme Court to rely on for clarification a guidance as evidence by their 1992 ruling stating that states can't force businesses to collect sales taxes unless the businesses have operations in that state. The court also said Congress could lift the ban, which remains in place - for now. 

And so it begins….. 

So, as it stands now, only businesses with a "physical presence" in a state - such as a store or office building - collect sales tax on products sent to buyers in the same state. For instance, a Californian buying something from Barnes & Noble Inc.'s Web site pays sales tax because the bookseller has stores in the Golden State. Buying the same thing directly from Amazon would not ring up sales tax. 

That doesn't mean products purchased online from out-of-state companies are necessarily tax-free. Consumers are usually supposed to self-report taxes on these items. This is called a use tax, but not surprisingly, it tends to go unreported. (I wonder WHY!) 

In hopes of unraveling the complex tax rules - and bringing states more money - 22 states and many brick-and-mortar retailers support the efforts of a group called the Streamlined Sales Tax Governing Board. The group is getting states to simplify and make uniform their numerous tax rates and rules, in exchange for a crack at taxing online sales. 

And as we know from experience, the individual States love to work hand-in-hand with each other….right? 

Among other things, participating states need to change how they define things such as "food" and "clothing." For example, one state might now consider a T-shirt clothing and tax it as such, while another might consider it a sporting good and tax it differently. 

SEE WHAT I MEAN? 

In response, more than 1,100 retailers have registered with the streamlining group and are collecting sales taxes on items shipped to states that are part of the agreement - even if they are not legally obligated to. 

The streamlining board also is lobbying Congress to let the participating states do what the Supreme Court ruling banned: They could force businesses to collect taxes on sales made to in-state customers, even if the businesses don't have a physical presence there. 

If there is one thing that can be concluded from this, it is that the problems of online state taxation is one bid “Gordian Knot”. 

However, with formidable proponents such as various states and retailers including Wal-Mart Stores Inc., Borders Group Inc., J.C. Penney Co. and the National Retail Federation, the industry's biggest trade group, the fight is going to be interesting. 

The Streamlined Sales Tax group hopes Congress takes up its uniform-tax idea in 2009, however Scott Peterson, executive director for the Streamline board, thinks the dismal economy boosts the chances of passage. 

Another industry analyst summed it up best saying, "It's a legal morass.….in a best-case scenario, it's going to take a while to sort everything out."

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