As the weather is heating up, the Texas tax front continues to bring hot and exciting developments in the Lone Star State.  Two of the latest updates usher in a change to the sourcing of local sales tax for certain internet sales and the end of Texas’s internet access tax.

Internet Sales  

The Texas Comptroller has adopted amended regulations under 34 Tex. Admin. Code § 3.34 relating to the location where an internet order is received at a place of business of the seller.  This rule change has the potential to impact a great number of internet sellers as well as most local Texas jurisdictions.

Traditionally, under the previous 34 Tex. Admin. Code § 3.334(h)(3)(C), when an order is placed over the internet and the seller fulfills that order at a location that is a place of business in Texas, the sale is considered to be consummated at that place of business where the order is fulfilled.  Accordingly, local sales tax is sourced to that fulfillment location.  However, under the Comptroller’s newly-enacted regulation, specifically 34 Tex. Admin. Code § 3.334(b)(5), “[o]rders not received by sales personnel, including orders received by a shopping website or shopping software application . . . are received at locations that are not places of business of the seller” (emphasis added).  As a result, under the newly adopted regulations, when an order is not placed in person at a location that is not the seller’s business, i.e. an internet website, that order is sourced to the purchaser’s address.

It has been a common practice during the past few years for local jurisdictions to enter into incentive agreements with retailers making large quantities of internet sales for those retailers to locate their fulfillment centers, also known as “customer service centers,” in those local jurisdictions.  As an effect, each local jurisdiction receives the relevant portion of the Texas local sales tax revenue, since that local jurisdiction is considered to be the location where the order is fulfilled, and that local jurisdiction then passes on incentives to the large retailers operating the fulfillment centers in the jurisdiction.  Additionally, The jurisdictions also received the benefit of due of additional economic activity taking place within their borders.  All in all, these incentive agreements benefitted both sides under the prior version of the regulation.  However, these agreements have also denied sales tax revenue to each local jurisdiction where an internet purchaser had his or her shipment delivered.  This revenue is critical to local jurisdictions, because the (up to) 2% sales tax is a primary revenue generator for local jurisdictions and Texas does not have an income tax.

The newly-adopted version of 34 Tex. Admin. Code § 3.34 has the potential to affect many internet retailers in Texas, as well as most local jurisdictions, because the rule will likely shift the sourcing of local sales tax income from a few local jurisdictions to a more broad-based pattern around the state.  As a result, those jurisdictions providing incentives will be hit the hardest because they will no longer receive the local sales tax from internet orders, since those orders are now sourced to the location of the purchaser’s address.  Continuing this theme, large retailers may also be hurt if these jurisdictions argue that the incentive agreements are now void – these retailers have likely factored in these tax incentives in their decision to locate their fulfillment center operations in Texas.  These large retailers will also have to change their tax collection systems to account for this new change.  At the end of the day, the clear winner is every local jurisdiction where purchasers’ sales are made, since the local sales tax will now be going to those locations.

This rule change has been extremely contentious – to the point of occupying eighteen pages in the Texas Register.  The rule change was proposed by the Comptroller in January 2020, and the Comptroller held a public hearing in February.  A bevy of state legislators, business groups, local development corporations, and local jurisdictions commented on the rule change.  Some of the commentators believe that the rule is inconsistent with its underlying statutes, while others commented that it could have other business implications.  And, on the other side, other jurisdictions cheered this rule since those jurisdictions will now receive tax revenues that they had not received before.  In fact, the rule was contentious enough that Glenn Hegar, the Texas Comptroller, published an opinion article in The Dallas Morning News on February 4 to defend the rule change.  That article’s title is indicative of the contentious nature of the change – “How Some Texas Cities and Retailers are Using a Tax Loophole to Snatch Sales Tax Revenue From Other Communities.”  It is a rare sight to see an article from Comptroller Hegar using contentious language.

The Comptroller’s Office specifically notes in the Texas Register that this rule does not go into effect until October 21, 2021 in order to “giv[e] interested parties an opportunity to seek a legislative change.”  It will be interesting to see if such a change is made in the next legislative session, which is scheduled for Spring 2021.  Only time will tell if this important new regulation is overridden by the Texas Legislature. 

Internet Taxes

The Texas Comptroller’s Office has also announced that, starting July 1, 2020, it is no longer imposing sales tax on separately stated internet access charges.  The Internet Tax Freedom Act, which was first passed in 1998, prohibited taxes on internet access.  However, Texas and six other states’ internet access taxes were grandfathered in that legislation, and in other successive renewals of the Internet Tax Freedom Act.  The last renewal of the Act, the Internet Tax Freedom Act of 2016, set an expiration date of June 30, 2020, for the grandfather clause.

Currently Texas exempts the first $25 of a fee paid to access the internet but imposes taxes on any amount exceeding $25.  After June 30, Texas will no longer be permitted to impose this tax unless a service provider offers a bundle that includes internet access and cannot establish a reasonable allocation for the nontaxable internet services.

Texas tax professionals are waiting to see how the Comptroller’s Office will make up this lost sales tax revenue.  In Comptroller Hegar’s 2020-2021 Biennial Revenue Estimate, the Comptroller’s Office estimated that this lost revenue will be approximately $500 million per year.  This loss of revenue, as well as the current decrease in sales tax revenue due to the COVID-19 pandemic, could create quite a challenge for Texas’s budget in the years ahead.

See the May 2020 Texas Tax Policy Newsletter, available at, for more information.

Contact the Authors: Stephen Long and Jimmy Lucas