This Sales Tax Administration Checklist will provide you with a list of exactly what to address for sales tax in each potential scenario your business goes through.
Who remembers Blockbuster, CD’s, and physical newspapers? These are a dwindling group of people as we’re in a digital age where a majority of the entertainment and news we consume is online or downloaded to our devices.
Some states already broadly tax digital goods and services. Some states only tax a specified list of digital goods like digital books and music, have a lower tax rate on certain digital goods and services, or exclude all digital goods and services from tax may start rethinking their positions in the next year.
States have been busy implementing big changes in just the past few years. Some have pursued taxing specific types of digital goods and services to generate new revenue streams while others are looking at bold aggressive changes. Another relatively recent development that states are beginning to explore is the taxation of cryptocurrency and non-fungible tokens (NFTs). New laws and regulations include allowing for commercial cryptocurrency mining operations to apply for an exemption for purchases of electricity.
Let’s take a look at recent legislation states have put on the books and delve into new trends and what to watch for in our virtual-driven world.
Digital goods like e-books, music downloads, and ringtones are not new technology. Many states have worked to subject some digital goods to sales tax, but rules across the states are in constant flux. When states adjust their rules, you must watch carefully for things like different rates for different goods and exemptions. You cannot rely on consistency when it comes to how states tax digital goods. Let’s look at some recent tax changes in the realm of digital goods.
Colorado is a state that has been applying sales and use tax to digital goods. Effective January of 2021, Colorado enacted new legislation codifying the treatment of digital goods as tangible personal property. The new amendments to the Colorado Revised Statutes expand the definition of tangible personal property to include all goods, wares, and commodities, and specifically includes digital goods regardless of their method of delivery. And inversely, Colorado defines digital goods as “any item of tangible personal property that is delivered or stored by digital means, including but not limited to video, music, or electronic books.”
Given Colorado’s status as a home rule state, some cities preceded the state in taxing digital goods while others may lag behind the state. Don’t forget to check for these differences at the local level.
Maryland has more recently been at the forefront of all things digital, including their sales tax on digital goods and digital advertising. Effective March 14, 2021, Maryland’s 6% sales and use tax on digital goods applies to a long list of (non-exclusive) digital products if obtained or delivered by electronic means. The list includes certain publications, digital downloads or streaming of news or entertainment, downloaded digitized sound files, a sale, subscription or license to access content online or use a software application, continuing education classes, and more. Maryland also noted that the sale of canned or commercial off-the-shelf software obtained electronically is considered a digital good and is subject to Maryland sales and use tax. In June 2022, Maryland Gov. Larry Hogan announced that he would let House Bill 791 become law without his signature. The bill – effective July 1, 2022 – clarifies that software as a service (SaaS) licensed or purchased solely for commercial purposes is not a taxable digital product.
Effective January 1, 2023, Kentucky is enacting tax on several services including software as a service (SaaS). The state made adjustments to their treatment of prewritten software access services, clarifying the definition: “the right of access to prewritten computer software where the object of the transaction is to use the prewritten computer software while possession of the prewritten computer software is maintained by the seller or a third party, wherever located, regardless of whether the charge for the access or use is on a per use, per user, per license, subscription, or some other basis.”
States that currently limit taxation in the digital space to digital goods may expand their reach to digital services. In early 2020, we saw this begin to surface with states proposing digital advertising tax legislation, but everyone has their eyes on one state in particular.
Even though we predict that digital goods and services will increasingly be taxed post-COVID, timing may be everything. In the first legislative session of 2020, the Maryland legislature passed a gross receipts tax on digital advertising that would have been effective July 1, 2020 (H.B. 732). Maryland defined digital advertising services as “advertisement services on a digital interface, including advertisements in the form of banner advertising, search engine advertising, interstitial advertising, and other comparable advertising services.” The gross receipts tax would apply on a sliding scale from 2.5-10% depending on annual gross revenues. In May, the Maryland governor vetoed the bill stating, “These misguided bills would raise taxes and fees on Marylanders at a time when many are already out of work and financially struggling. With our state in the midst of a global pandemic and economic crash, and just beginning on our road to recovery, it would be unconscionable to raise taxes and fees now.”
But the Maryland story doesn’t end there. The Maryland legislature overrode Governor Larry Hogan’s veto of a new tax on digital advertising (H.B. 732) on February 12, 2021, making Maryland the first state in the country to adopt a tax on digital advertising. The state began moving forward but was quickly met with pushbacks from groups such as the Internet Association, whose members include Amazon, Facebook and Google. They argue that this tax (the first of its kind) is unconstitutional and incompatible with federal laws that prohibit targeting online services on the state level. On October 17, 2022, a Maryland circuit court judge ruled that the tax on digital advertising violated the Internet Tax Freedom Act, as there is no similar tax for nondigital advertising in the state, and the First Amendment, by exempting news media from the tax.
The Maryland Attorney General’s office is currently reviewing their options and the ruling to determine their next steps. The law remains under challenge in federal court, in a case that also focuses on the ability of companies subject to the law to pass-through the tax to their customers. We’ll keep you up to date on our dedicated page. The tax world will be watching! A loss by Maryland on this issue may delay other states from following Maryland’s lead. But, the states can be creative when they see a significant potential revenue stream.
When it comes to non-fungible tokens (NFTs), the states are just getting started on providing guidance on their taxation. It takes time for states to figure out what to do and update their tax laws when new developments like this come along. But there are a few states that have reacted quickly.
Wisconsin has issued guidance on the taxability of NFTs in its November 2022 monthly tax bulletin. Per the bulletin, the sale or purchase of an NFT may be taxable if the underlying product, good, or service is taxable in Wisconsin. The state goes on to provide a few examples, such as, “If the NFT entitles a purchaser to download music or movies, the sale of the NFT is a taxable specified digital good.” Wisconsin’s guidance follows guidance from several other states. Minnesota provided similar guidance to help reduce the complexity of taxing and reporting use of NFTs. The state recommends those receiving or using payments of NFTs to check the Minnesota Department of Revenue’s website for further details.
The state of Washington’s situation differs from other states addressing NFTs because sellers of NFTs can be subject to not just sales or use tax but also the Washington business and occupation (B&O) tax. While the state has not yet developed comprehensive, permanent guidance, the Department clarified that purchases of NFTs are taxable in most cases.
On a similar note to NFTs, the states have yet to provide a lot of guidance on cryptocurrencies. However, there are specific cases where the topic has arisen. The Minnesota Department of Revenue provided updates to its fact sheet that covers Coupons, Discounts, Rewards, Rebates, and Other Forms of Payment. The state of Kentucky enacted a new sales tax exemption for electricity that is used or consumed in the commercial mining of cryptocurrency. Delaware addressed cryptocurrency in the context of unclaimed property. The governor signed a bill June 30, 2021, that will add “virtual currency,” including cryptocurrency, to the definition of property subject to reporting requirements for unclaimed property.
Business innovation will continue to drive the creation of new products and services. NFT’s are just one of the latest. States have and will continue to lag behind innovation in developing tax policy. Cooperation between the state policy and businesses will be key to increasing the speed at which tax guidance is made available. We expect to see guidance from additional states on this emerging technology and will keep you updated.
You need to understand the differences in how digital goods and services are taxed across the states and trends to watch for no matter if you work on the buyer or seller side of these transactions. States are continuing to enact legislative changes that determine how they characterize sales of software, and the presence of digital currencies is growing.
So much of our interaction, business, education, and entertainment happening virtually, paired with a constant emergence of new digital products make digital goods and services prime targets for new revenue streams. States are getting quicker at keeping up with technology and inspire each other, as you learned with the emergence of similar digital advertising bills this year.