A brief explanation of sales tax on digital goods
Ahh, taxes. Ben Franklin famously said nothing in life is certain except death and taxes. And fear not, digital goods purveyor, the taxman is a-coming. The uncertainty, though, is what for?
Taxes on digital goods are set by each state, just like any other sales tax. Traditionally, businesses are not required to charge sales tax on goods sold in states where they did not have a physical presence. But with the proliferation of the online marketplace, and the creation of non-tangible, digital goods that you can sell online to anyone, anywhere – things like digital audio files, video files or images, or electronic books – sales tax becomes a more complicated issue. As it stands, if the seller is located in one state, the buyer in another, and the server for the seller’s business in a third, theoretically all three states could lay claim to the sales tax from a single transaction. Congress has been considering legislation to create a federal-level framework so that sellers and consumers understand who is taxed when. The Digital Goods and Services Tax Fairness Act would, for example, define digital goods and limit the sales tax collection to the state where the buyer resides. The House Committee on Finance is currently considering it. But until Congress addresses this issue, the states are individually responsible for determining how digital goods are taxed.
When are digital goods taxed?
As a seller, you are responsible for sales tax collection in the states where you have a business presence. This may mean you are physically located in the state, or that you have representatives or affiliates in the state selling your goods. It could also be based on your temporary presence in the state, if it’s significant enough. A good first step is to contact your state tax board to ask how to register for a sales tax license and to find out how they tax digital goods. You must have a license to collect sales tax, but not having one does not exempt you from a legal requirement to collect sales taxes. For these reasons, and those further discussed below, it may be wise to meet with an accountant who has experience in online sales to help you determine when, what for, and how much to collect.
How are digital goods taxed?
Every state taxes digital goods in a different way, but there are generally two categories. These categories include taxing digital goods as tangible property or the equivalent of tangible property and taxing digital goods separately and specifically within their tax code. North Dakota and Washington, DC currently don’t tax digital goods.
Digital goods may be taxed like tangible goods
The states that tax digital goods as under their existing tax code do so by defining tangible personal property very broadly, sometimes clarifying that the “equivalent” of the tangible item is the same as the item itself for purposes of the tax code. Some states even define equivalents as electronic versions of the item in question. By defining tangible personal property very broadly, states do not have to specify what a digital good is in their tax code. The states that define tangible personal property very broadly to encompass digital goods are: Alabama, Arizona, New Mexico, Utah, and West Virginia. The states that define electronic versions as equivalents of tangible property are: Indiana, Louisiana, Maine, and Texas.
Digital goods may be specifically defined
Other states have gone further and passed legislation to specifically define digital goods and describe how they are taxed. These states are: Colorado, Idaho, Kentucky, Nebraska, New Jersey, South Dakota, Tennessee, Vermont, Washington, and Wisconsin.
The Streamlined Sales Tax Governing Board
Because of the potential for inconsistency between states, an organization called the Streamlined Sales Tax Governing Board formed. The purpose of this group is to provide a universally accepted definition of digital goods and to lobby for the uniformity of sales tax regulations relating to digital goods across the states. For example, categorizing digital goods in the same way in each state will hopefully improve transparency and efficiency for a seller collecting taxes in many different states. This organization has defined digital goods to include items such as digital cards, music, movies, pictures, and ringtones. Member states are required to adopt these definitions, and if they want to tax digital products that fall outside these terms, they must pass legislation specific to those products.
The group created the Streamlined Sales Tax and Use Agreement, which:
- minimizes costs and administrative burdens on sellers who collect sales tax, specifically those operating in multiple states like online sellers;
- encourages online sellers to collect tax on sales to customers living in the Streamlined states;
- levels the playing field so that local “brick-and-mortar” stores and remote sellers operate under the same rules, and
- ensures that all retailers can conduct their business in a fair, competitive environment.
The Agreement is not meant to circumvent current tax laws or specify tax rates, but rather create consistency and clarity on how taxes are collected. Like the legislation in front of Congress, it would also limit collection of sales tax to the location of the purchaser. Currently, twenty-four states have passed legislation complying with the Agreement. Those states are: Arkansas, Georgia, Indiana, Iowa, Kansas, Kentucky, Michigan, Minnesota, Nebraska, Nevada, New Jersey, North Carolina, North Dakota, Ohio, Oklahoma, Rhode Island, South Dakota, Tennessee, Utah, Vermont, Washington, West Virginia, Wisconsin and Wyoming.
Because tax laws vary by state and become even more complicated when digital goods are being sold, it is important for any business owner who sells digital products online to get clarity on what your state requires. The best ways to do that are to contact your state’s tax and revenue board and to discuss your specific sales transmission methods and products with an accountant knowledgeable in online sales tax.