Broadening the US sales tax base:  A shift to a digital economy

When states began adopting modern-day sales tax regimes during the Great Depression, the main focus was on the retail sale of tangible goods. As personal and business consumption has shifted to professional services and the digital economy, state sales tax revenues have eroded.

Few states still assess sales tax solely on tangible personal property. To combat budget shortfalls and to fund discretionary spending, many states are aggressively expanding their sales tax base to include previously untaxed goods and unenumerated services.

Digital products and related services

Digital products, such as cloud-based software and streaming video, music, and gaming services, were created long after states established sales tax frameworks. Some states consider digital products tangible property since they are “perceptible to the senses” and tax them like their tangible counterparts (e.g. software delivered via CD or a physical book).

Meanwhile, some states have enacted separate laws to address the taxability of digital products, defining them as a distinct sales tax category or enumerating them as a taxable service. Subscription-based software-as-a-service and media streaming services have been enumerated as taxable services in about half of US states.

Also, since software is rarely licensed as a standalone product, related services (e.g. implementation, training, etc.) can be taxable if performed by the same person who sold the computer program.

Digital advertising

About a dozen states have proposed legislation for digital advertising taxes either by expanding their sales tax base or by creating new tax regimes. Only two states have enacted such a tax – Maryland and Washington.

However, Maryland has faced legal challenges claiming the tax violates the Internet Tax Freedom Act  – for taxing digital advertising but not non-digital, and the US Constitution’s Commerce Clause. Recently, US officials spoke out against France’s digital service tax. For Maryland to enact a similar tax is counterproductive. The US Supreme Court ruled in 1979 that state taxes that prevent the United States from “speaking with one voice” when regulating foreign commercial relations violate the Foreign Commerce Clause.

Some services performed by digital advertising agencies may be taxed – notably, website development and hosting, which would fall under the previously mentioned digital products and related services.

Businesses should not and cannot rely on outdated notions that goods and services are not taxable in the absence of a tangible product, particularly those ever prevalent in a digital economy.

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Michael Szewc State and Local Tax Director at Mowery & Schoenfeld, specialises in guiding large organisations through complex state and local income, sales and use, and franchise tax challenges. He also serves as North American Regional Chair of GGI’s Indirect Taxes Practice Group, connecting global expertise with practical solutions.