Who remembers Blockbuster, CD’s, and physical newspapers? We 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.
Since people spent a lot more time at home in 2020, tax revenue from traditional brick and mortar retail is down. States are increasingly turning to expanding tax bases to include digital goods and services to combat revenue stress due to the pandemic.
Some states already broadly tax digital goods and services. States that 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. 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 the virtual-driven environment of 2020.
Digital goods like e-books, music downloads, and ringtones are not new technology. Around two-thirds of 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.
Connecticut was an early adopter of taxing digital goods and services. Under pressure to reduce the burden, a phase out of the tax was enacted. The sales and use tax rate for computer and data processing services other than Internet access services was reduced in annual increments starting July 1, 1997 and became taxable at 1% effective July 1, 2001. However, when the state budget pressure got too great, it stalled at 1% where it sat for years.
Following trends to broaden the base, effective October 1, 2019, the state reworked its definition of tangible personal property to include digital goods to tax them at the full 6.35% sales tax rate. The business lobby won out however, and business use of most digital goods continue to be taxed at the reduced 1% rate. Sales of newspapers, magazines by subscription, and college textbooks whether sold as physical copies or electronically accessed are exempt.
In 2019, North Carolina clarified its position that sales and use tax is imposed on “certain digital property.” The legislation eliminated the requirement that digital property must have a taxable, tangible corollary in order to be subject to tax. The types of digital property subject to tax are audio works, audiovisual works, a book, magazine, a newspaper, a newsletter, a report, or another publication, and a photograph or greeting card.
North Carolina later issued retroactive sales and use tax exemptions in 2020 for sales of a digital audio/audiovisual work that is a qualifying education expense to the operator of a home school and sales of a digital audio/audiovisual work that consists of nontaxable service content when the electronic transfer of the digital audio work or digital audiovisual work occurs contemporaneously with the provision of the nontaxable service in real time.
In early 2019, Washington D.C. passed emergency legislation to subject sales of digital goods to sales tax, including: digital audio/audiovisual works, digital books, digital codes, digital applications and games, and any other otherwise taxable tangible personal property electronically or digitally delivered, whether electronically or digitally delivered, streamed, or accessed.
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 several states proposing digital advertising tax legislation.
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 this year, the Maryland legislature passed a gross receipts tax on digital advertising that would have been effective July 1, 2020 (H.B. 732) as well as a bill that would have subjected certain digital products to Maryland sales and use tax, including streaming and downloads (H.B. 932). 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.”
The Maryland story doesn’t end there. Per a recent Council on State Taxation Legislative alert, Maryland legislative leaders plan to override the Governor’s veto on the two bills with digital implications in the next legislative session in January 2021. The tax world will be watching!
New York and Nebraska also introduced digital advertising bills this year and put them on hold.
New York followed Maryland’s lead, introducing a nearly identical digital advertising tax bill in April. However, New York S. 8166 would impose sales tax on digital advertising services with revenue dedicated to a zero-interest student loan refinancing program. New York’s definition of digital advertising services mirrors Maryland’s definition, only differing in its extension of the last clause: “other comparable advertising services which markets or promotes a particular good, service, or political candidate or message.” The New York bill has yet to make it out of committee.
Nebraska introduced LB989 to impose sales and use taxes on digital advertisements. The bill defines a digital advertisement as “an advertising message delivered over the Internet that markets or promotes a particular good, service, or political candidate or message.” The bill would have taken effect on October 1, 2020 (just ahead of the 2020 election!) but the bill was indefinitely postponed on August 13.
Many tax policy organizations and practitioners oppose digital advertising legislation due to negative effects on businesses. Maryland, Nebraska, and New York do not currently tax non-digital advertising services, so the digital advertising taxes are seen as discriminatory. This is something to monitor as well as the expansion of sales tax on digital goods, SaaS, and software. We expect a number of states to revisit these tax base expansion options during the 2021 legislative session.
Everyone from school-aged kids to working professionals are receiving their education and training in digital formats in 2020. As a purchaser of online training, should you expect to see sales tax? If you’re a provider of online training, should you be worried about collecting sales tax on your offerings?
Overall, the delivery method matters. Online courses that are self-paced or on-demand are more likely to be taxed across the states than online courses conducted live. Online events do meet the definition of a “digital audio visual good” in Streamlined Sales Tax member states, but it’s unlikely states had online education in mind when the definitions were developed.
Wisconsin, a Streamlined state, released guidance several years ago on online educational services to clarify the state’s position. Sales of live digital online educational services, like webinars, are not taxable in Wisconsin. Sales of pre-recorded webinars are generally taxable unless the pre-recorded webinar is “incidental” to an educational service purchase. It may be considered incidental if the participant is evaluated by an instructor or is connected to other participants/the instructor via the Internet or other online network.
In September 2020, Tennessee added three new FAQs to its website discussing the taxability of pre-recorded videos of online courses. A pre-recorded video of a previously live-streamed online course accessed by Tennessee consumers is subject to sales tax as a sale of access to a specified digital product. Unlike in Wisconsin, a participant’s ability to ask the instructor questions via email during or after the online course, does not change the taxability of the pre-recorded course.
Like Tennessee, other state departments of revenue may begin to re-enforce, clarify, or reconsider their positions when it comes to the taxation of online education and training in light of the demand for these types of products.
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.
The context of 2020, with 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.
Our upcoming webinar, Taxation of Software and Digital Goods, will teach you how to manage sales tax correctly for software and digital goods transactions. You’ll learn about important recent legislative changes, practical issues like contracting and invoicing, and cost-saving exemptions to help you save time and avoid costly mistakes.
Join us to dive into all the crucial sales tax considerations for software, digital goods, and their related services.