Sales Tax on Digital Goods: A Guide for Businesses
In an increasingly digital world, the way we consume products and services is evolving rapidly. From streaming services to e-books, the rise of digital goods has transformed the marketplace. With this shift comes the need to understand how sales tax applies to digital goods and products in the US. This guide aims to demystify the complex landscape of sales tax on digital goods, providing you with a clear understanding of how these taxes work and what you need to know as a business owner.
Understanding digital goods and products
Before diving into sales tax laws, it’s important to clarify what constitutes digital goods and products. Digital goods, also known as digital products, include a wide range of items such as:
- E-books and audiobooks
- Music and video downloads
- Streaming services (video, music, and gaming)
- Software and applications
- Online courses and educational materials
- Digital artwork and photography
Essentially, any product that is delivered electronically rather than physically falls into the category of digital goods.
However, it’s important to differentiate digital products from Software as a Service (SaaS). While digital products are typically one-time purchases that the user can download and keep, SaaS involves accessing software on a subscription basis, often hosted in the cloud. This distinction is crucial as sales tax laws can differ significantly between digital products and SaaS.
Sales tax on digital goods: a state-by-state approach
Sales tax laws in the United States can be notoriously complex due to the fact that they vary significantly from state to state. When it comes to digital goods, the situation is no different. Some states impose sales tax on digital products, while others do not, and the rules can be quite specific.
States with full sales tax on digital goods
Some states have implemented comprehensive sales tax laws that apply to all types of digital goods. In these states, consumers can expect to pay sales tax on digital products just as they would on physical goods. Here are the states with full sales tax on digital sales:
- Alabama
- Arkansas
- Connecticut
- Hawaii
- Idaho
- Kentucky
- Louisiana
- Maine
- Minnesota
- Mississippi
- Nebraska
- New Jersey
- New Mexico
- New York
- North Carolina
- Ohio
- Pennsylvania
- Rhode Island
- South Dakota
- Texas
- Utah
- Vermont
- Washington
- West Virginia
- Wisconsin
- Wyoming
These states have clear regulations that require sales tax collection on digital goods, making compliance straightforward for businesses operating within these jurisdictions.
States with no sales tax on digital goods
In contrast, several states have chosen not to tax digital goods at all. Consumers in these states can purchase digital products without the additional cost of sales tax. The states that do not impose sales tax on digital goods are:
- Alaska
- Delaware
- Montana
- New Hampshire
- Oregon
For businesses and consumers in these states, the absence of sales tax on digital goods simplifies transactions and reduces the overall cost of digital purchases.
States with conditional sales tax on digital goods
Some states have more nuanced sales tax laws that apply conditionally to digital goods. These conditions can depend on factors such as the type of digital product, the delivery method, or specific exemptions. Here are the states where sales tax conditions apply:
- Arizona: Taxes digital goods if they are downloaded rather than streamed.
- California: Digital goods are generally not taxable unless they are delivered with physical components, like a backup CD or printed manual.
- Colorado: Digital goods are generally exempt unless bundled with physical goods.
- Florida: Applies sales tax to digital goods if they are sold with tangible personal property, such as a physical copy or download code.
- Georgia: Digital goods are exempt unless the transaction involves tangible personal property.
- Illinois: Taxes digital goods delivered on physical media, such as a disc.
- Indiana: Exempts most digital products unless provided in a tangible medium.
- Iowa: Digital products are taxed only if they are sold in a tangible format, such as software on a disc.
- Kansas: Applies sales tax to digital goods if they include tangible components.
- Maryland: Digital goods are generally exempt unless bundled with tangible personal property.
- Massachusetts: Digital goods are exempt from sales tax unless delivered on physical media.
- Michigan: Taxes digital goods if they are delivered on physical media.
- Missouri: Digital goods are generally exempt unless bundled with physical goods.
- Nevada: Digital goods are exempt unless bundled with tangible property.
- North Dakota: Digital goods are taxable if delivered on physical media.
- Oklahoma: Applies sales tax to digital goods only if they are sold with tangible personal property.
- South Carolina: Digital goods are generally exempt unless delivered on tangible media.
- Tennessee: Digital goods are generally exempt unless delivered on physical media.
- Virginia: Digital goods are exempt unless bundled with tangible property.
In these states, it is crucial for businesses to carefully review the specific conditions under which sales tax applies to their digital products. Compliance requires a detailed understanding of state-specific regulations and exemptions.
Determining sales tax nexus for digital goods
Determining whether your business has a sales tax nexus in a state is a critical step in understanding your tax obligations. A sales tax nexus is a connection between your business and a state that requires you to collect and remit sales tax. Here’s how to determine if you have a nexus for digital goods:
Physical presence nexus
Traditionally, having a physical presence in a state—such as an office, warehouse, or employees—creates a sales tax nexus. If your business operates from a specific location or has physical assets in a state, you are likely required to collect sales tax on digital goods sold to customers in that state.
Economic nexus
With the rise of e-commerce, many states have adopted economic nexus laws. Economic nexus is based on the amount of sales or number of transactions a business has in a state, regardless of physical presence. For example, if your business exceeds a certain sales threshold (often $100,000) or number of transactions (commonly 200) within a state, you may have an economic nexus and be required to collect sales tax.
Marketplace nexus
If you sell digital goods through an online marketplace, some states impose sales tax obligations on the marketplace itself rather than individual sellers. However, it’s important to verify whether the marketplace is handling tax collection on your behalf or if you still have responsibilities.
Affiliate nexus
Having affiliates or representatives in a state who promote your products can also establish a nexus. This is often referred to as click-through nexus, where online referrals from in-state affiliates create tax obligations.
Temporary presence nexus
Even temporary business activities, such as attending trade shows or holding inventory temporarily in a state, can create a nexus. Businesses should be aware of the potential for nexus from these short-term activities.
Steps to determine nexus
- Review state laws: Each state has its own rules for establishing a nexus. Review the specific sales tax nexus laws in the states where you do business.
- Track sales and transactions: Keep detailed records of your sales and transactions in each state to monitor whether you meet economic nexus thresholds.
- Consult with professionals: Tax professionals or legal advisors can provide valuable insights and help ensure compliance with nexus laws.
Navigating sales tax as a business owner
For businesses selling digital goods, understanding and complying with sales tax laws is crucial. Here are a few steps to ensure you are in compliance:
Determine nexus
As previousñy mentioned, the first step is to determine if your business has a sales tax nexus in a state. Nexus is a legal term that refers to the requirement for a business to collect sales tax in a state if it has a significant presence there.
Identify taxable products
Identify which of your digital products are subject to sales tax in each state where you have nexus. This can involve a detailed review of state laws and may require consultation with a tax professional.
Register and collect sales tax
Register for a sales tax permit in states where you are required to collect tax. Then, ensure you are correctly collecting and remitting sales tax on applicable digital goods.
Stay informed
Sales tax laws are subject to change, so it’s important to stay informed about the latest regulations in the states where you do business. Regularly review updates from state tax authorities and consider subscribing to tax law updates.
Conclusion
Understanding sales tax on digital goods in the US is essential for business owners. Given the varying sales tax laws across states, it’s important to stay informed and compliant with the latest regulations. Whether you’re selling an e-book or a software application, being aware of the tax implications can save you from potential headaches down the road.
By staying informed and proactive, you can navigate the complexities of sales tax on digital products and ensure a smooth experience in the digital marketplace.
Do you need help with your sales tax compliance? Book a free call with one of our sales tax experts to find bespoke solutions for your business, optimize your tax costs, and reach millions of new potential customers.
Frequently Asked Questions
What determines if I need to charge sales tax on digital products?
You need to charge sales tax on digital products based on the tax nexus and revenue thresholds of the state where your business operates and where your customer is located. This determines if you are required to collect sales tax on digital goods.
Are all digital products taxable across the US?
No, the taxation of digital products varies by state in the US. Some states like Delaware and New Hampshire do not require sales tax on digital products, while others tax them fully as tangible personal property.
Can the location of my customer affect how much sales tax I need to collect?
Yes, the location of your customer can affect the amount of sales tax you need to collect, as sourcing rules follow the destination principle, which considers the buyer's location when determining sales tax. This means that the tax rate applied could vary depending on where your customer is located.
Will there be changes in digital goods taxation in the near future?
Yes, there will likely be changes in digital goods taxation in the near future, as states adapt to the evolving digital economy and explore new revenue sources. This may include expanded taxation on digital advertising, cryptocurrencies, and NFTs.
