One of the main legal issues that online entrepreneurs must face is whether they are legally required to collect e-commerce sales taxes on digital goods. This post will help to clarify that question.
What is E-commerce Sales Tax?
Before we dig into the nuts and bolts of whether you need to be charging sales tax on your digital products, let’s quickly discuss what e-commerce sales tax is.
Whether you are selling products or services online, or through a physical retail shop, sales tax is the small amount of tax that is added to a sale when you check out.
Sales tax is only paid by consumers who purchase certain goods or services, so in this regard it is considered a “consumption tax” and is collected in 45 U.S. states and in the District of Columbia.
As of this writing, there is no such thing as a “national” sales tax in the United States. Rather, sales taxes are governed and collected by the individual U.S. States.
When you are selling physical products online, the answer is fairly simple. Yes, you will need to collect sales taxes in most states unless your store has a physical or economic nexus (more on that later) with one of the NOMAD states that do not collect sales taxes. These states include:
- New Hampshire
- Oregon
- Montana
- Alaska
- Delaware
For anyone located in one of the other 45 states and the District of Columbia, you will likely need to collect sales taxes if you are selling any type of physical, tangible product.
Do I Need to Collect Sales Taxes on Digital Goods?
It depends.
The issues becomes a bit more complicated when you start selling digital products. Let’s start with a quick overview of what digital products are and then we will discuss how you can determine whether you need to charge sales taxes on the sale of those products.
What are digital goods anyway?
Digital goods (also referred to as digital products) are products that do not have a “tangible” form. In other words, you can’t pick them up and hold them, smell them, or taste them.
These are products that are typically delivered through the internet, and are available for the consumer to download, stream to their device, or otherwise access through your website.
Here are some examples of the broad categories of digital products:
- Digital Images including photographs and artwork
- Audio Files including music and ringtones
- Video Files
- Text documents, including pdf’s, word processing documents, spreadsheets, etc.
- Plugins and software programs
- Website Themes
- E-Books
- Printables
- Online courses
- Magazine and Newspaper subscriptions
So, Do You Have to Charge Sales Tax on Ecommerce Sales for Digital products?
If you are required to collect sales taxes because you have a nexus in a given state, and the product you are selling is subject to sales tax in that state, then yes, you need to collect and remit sales tax to the state taxing authority.
Here is the basic analysis that will help you determine if you need to collect sales taxes:
- Do you have a nexus with a state that charges e-commerce sales tax?
- Is the digital product you are selling subject to sales tax in that state?
If the answer to both of these questions is yes, then you will need to collect sales taxes. If the answer to one of these questions is no, then you are not required to collect sales taxes in that state.
Let’s talk about these subjects in a bit more detail:
What constitutes having a “nexus” with a state that charges sales tax?
Nexus is a fancy legal term for saying that you have a connection with a certain state. When you have a nexus with a state, you are legally required to pay sales taxes to that state. This assumes that the products you sell are subject to sales tax.
There are two primary tests that will help you determine whether your business has a nexus with a state. There is physical nexus and economic nexus.
With regards to the physical nexus, this generally means that your business, inventory, or employees are located within the state. In other words, you will have a nexus with the state where your business is located.
However, you may also have a physical nexus with other states as well. This can happen in the following situations:
- You have another office, store, warehouse, etc. in another state.
- You store inventory in another state that is not your home state.
- You have affiliates who promote your products for a commission and have businesses in other states.
- You sell products from a tradeshow or other event outside of your home state.
So as you can see, whether or not you have a physical nexus with a state is a complicated analysis.
But you also might have an economic nexus with a state. This typically occurs where you sell products to consumers who live in another state. If the dollar amount of sales to consumers in that state exceeds a state-mandated dollar amount or number of sales, then you may have a nexus with that state.
Generally speaking, to have an economic nexus with a state, you must have at least $100,000 in gross revenue, or 200 transactions within that state. For more information on what constitutes a “nexus” with each individual state, here is a good summary.
Is the digital product you are selling subject to Sales Tax?
Assuming you do have a physical or economic nexus with a state, then the next question becomes whether or not the product you are selling is subject to sales tax.
State laws vary on how they define digital products, and to what extent they are subject to sales tax.