To the uninitiated, selling digital products and services can seem like a much easier business model than selling physical goods. While there may be advantages to skipping inventory and warehouse needs, the digital tax landscape can be tricky to navigate.
What are Digital Taxes?
Digital taxes are a form of state and local taxes (SALT) incurred when a person buys a digital product or service. They are assessed to the buyer and required to be collected by the seller, who then files tax returns and remits them to the appropriate state.
For each transaction, the seller needs to determine which state will receive the tax funds, register their business in the state (prior to the sale), and understand their taxation rules for digital products.
What are Digital Products and Services?
Digital products and services provide a utility or benefit to the user but are not tangible. Typically, we think of digital products being delivered electronically or online.
Just like physical products, digital products are sometimes free (such as an app that gives you access to physical products) or they can be purchased for a time period such as a single use, a month, or permanently. When a digital product or service is purchased, it triggers the seller to collect taxes.
Here are some examples of digital products and services:
- eBooks and online newspaper subscriptions
- Streaming services for movies and television programs
- Digital games that are played online or downloaded to run on a local device
- Music files, ringtones and podcasts
- Photographs delivered electronically
Why are Digital Taxes Complicated?
Sales and use tax regulations were originally written for tangible products before digital products were available. Each state creates sales and use tax laws individually, and while state lawmakers may look to each other for guidance, they ultimately determine their own state tax regulations.
Figuring out which state’s taxes to apply is another complication. When the buyer and seller live in two different states or corporate headquarters purchase software licenses that will be used in their offices located in many states, the seller needs to apply the correct state’s tax. Usually, sales and use taxes are assessed by the destination or the buyer’s home state.
Other things that complicate digital taxes:
- Some states tax individual purchasers differently than business purchasers. For example, Connecticut does this for ‘canned’ software purchases.
- How the product is delivered, such as software delivered on a storage device (like a CD or flash drive), can be taxed differently than the identical product downloaded from the internet.
- States may only tax some digital products while others are exempt. This is particularly challenging because it requires sellers to analyze each type of product they are selling in each jurisdiction where the product or service is sold or used.
- Sellers need to be aware of state sales and use tax holidays that often occur before back-to-school time requiring them to adjust their process for invoicing sales tax for temporary periods.
- Many states remain vague or silent on the tax treatment of digital goods and services requiring the seller to consider whether they should collect the tax or risk a potential tax bill in the future.
- State taxation rules can and do change regularly.
General Categories of Digital Tax Regulations
Despite the complications, there are some general groups that states fall into.
- States that generally tax digital products when they tax their physical equivalent
- States that generally exempt digital goods and services
- States that tax some digital products and exempt others
Digital Product and Service Taxation (as of 7/22/22)
As technology evolves, additional types of digital products and services will become available, and more businesses will create and sell them. States will continue to maintain their individuality and tax regulations are unlikely to become simpler.
Sales and use tax software and services can help companies with calculating and collecting taxes. However, the ultimate responsibility for registering the businesses in each state, collecting the appropriate taxes for their transactions, filing tax returns and remitting the funds to the state will remain with the seller.
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If you would like to learn more about digital taxes and how they apply to your business, please contact us today.