Traditionally, sales tax has been imposed on tangible personal property – that is, goods that you can see and touch. But as technology has developed and become progressively more popular, some states have slowly expanded their imposition of sales tax into intangible property like digital goods and services. 

Digital goods and services includes intangible property such as electronic books, music and movie downloads, streaming services, data processing services, information services, software as a service, and more. However, there is a pervasive lack of uniformity among the states, leaving taxpayers with multi-state obligations confused and uninformed. 

Complexities of Taxing Digital Goods & Services

Technology is always evolving faster than tax law, which presents many challenges for companies offering digital products. As mentioned above, some of the common areas of digital taxation include video streaming services and cloud products, but emerging technology such as online educational courses, NFTs, the metaverse, and data mining are far from established in state tax law.1

The issue is not always if your product is taxable, but rather how it is taxable. Before you can even determine taxability in a given state, you must first determine how your product is characterized based on that state’s definitions. Is it software as a service (SaaS)? Is it data processing? Is it cloud computing? Or is it another, unclassified service that has not yet been addressed by tax law or regulations? 

Multistate Tax Commission’s Approach

In 2021, the Multistate Tax Commission undertook a study on state treatment of digital products for sales tax purposes, with the goal of identifying potential processes that states could adopt to promote uniformity among the states.2 In an analysis by Jonathan White for the Multistate Sales Taxation, White stated: “It’s not just the tax bases that differ [among states]; the entire characterization of single items can be wildly different based on statute writing from decades ago.”3 White gives this example: In Washington, cloud computing products are taxed as “digital automated services,” which is a defined term in Washington statute.4  The same products, however, are taxed in South Carolina as “tangible personal property,” and in Texas as “data processing services.”5 Naturally, these vast differences make it extremely difficult for businesses to comply with tax laws in multiple states.

States are hesitant to establish specific, narrow definitions because narrow definitions have less administrative flexibility and will require further legislative changes as technology continues to adapt.6 Of course, there is also the risk that a narrow definition will inadvertently exclude some digital goods and services, therefore also excluding a potential revenue source for the states. Narrow definitions further require the state to develop extensive, complicated exemptions for products that do not fall under the narrow definition. Broad definitions, on the other hand, might not offer enough clarity for companies with digital goods and services.7 The answer is somewhere in the middle, but most states have not cracked the code just yet. 

State-Specific Examples

In the same study conducted by Jonathan White, he could not observe any obvious patterns between states regarding their digital tax bases, which highlights the lack of uniformity.8 However, he did identify a few states, like Texas, Washington, South Carolina, and South Dakota, that broadly tax digital goods.9 Nevada and Florida were highlighted as states with narrow digital goods tax bases.10

Let’s look a little more closely at states with a broad definition. Texas imposes sales tax on many digital goods and services by characterizing them as “data processing services” or “information services.”11 This can include products like computerized data, information storage, manipulation of data, the use of a computer for data processing, and more.12 South Carolina has taken a different, yet equally broad, approach by applying its statutory definition of tangible personal property to a variety of digital products. These broad tax bases result in Texas and South Dakota imposing sales tax on most digital products, because these products can fit into their broad definitions. 

Steps for Business Owners

If you are a business owner with digital goods or services, this information may seem particularly daunting. You may have even faced some of these challenges already when determining if and how to apply sales tax laws to your digital products. 

There are steps that can be taken to navigate this digital world of taxation. First, a detailed analysis of state law must be conducted. This usually involves research into the state’s laws, regulations, guidance, informational publications, and more. It may also involve calls with state Department of Revenue representatives or written requests for guidance. If your product is particularly new or complex, or the state’s laws are especially unclear, you may also need to request a letter ruling. Letter ruling requests are issued by the state Departments to provide guidance on taxability based on your specific facts and circumstances, and they can be relied upon on audit. 

Still overwhelmed? State Tax Advisors can assist with all of your concerns regarding digital goods and services. Our experienced team will guide you through the process, so you don’t need to worry about the complexities of digital goods and services in a digital world. 

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1. https://www.mtc.gov/wp-content/uploads/2023/06/Notes-from-Meeting-with-Avalara-Reps-March-28-2023.pdf

2. https://www.mtc.gov/wp-content/uploads/2023/02/Subcommittee-Recommendation-Proposed-Digital-Goods-Project-FINAL.pdf

3. https://www.mtc.gov/wp-content/uploads/2023/06/Written-summary-of-research-update-on-state-treatment-of-digital-products.pdf

4. Id. 

5. Id. 

6. https://www.mtc.gov/wp-content/uploads/2023/12/CriteriaForTaxBase.pdf

7. Id. 

8. https://www.mtc.gov/wp-content/uploads/2023/06/Written-summary-of-research-update-on-state-treatment-of-digital-products.pdf

9. Id.

10. Id.

11. Id.

12. Tex. Tax Code Ann. 151.0035.