Why Sellers of Software and Digital Goods Must Consider Sales Tax

Erik Wallin
May 4, 2021

Economic nexus thresholds have become standard procedure for most U.S. states, but the taxability of software and digital products continues to vary across taxing jurisdictions.

Software and digital goods suppliers understandably have questions about sales tax. Where do my digital products or software have special tax treatment? How do I handle sales tax with bundled products? Should I consider the delivery method when applying sales tax rates?

Businesses selling software or digital products cannot afford to keep sales tax as an afterthought. Understanding the right questions to ask about sales tax and how it applies to software and digital goods will ensure organizations can better gauge any potential tax liability.

What is being sold?

Understanding what is being sold is a very important question, one which often reveals how a transaction will be taxed. All states tax sales of tangible personal property (TPP) unless specifically exempt, but services, software and other transactions (including software-as-a-service) can often have varying taxability across taxing jurisdictions in the U.S. In some jurisdictions, software-as-a-service (SaaS) may be categorized as a service, while in other jurisdictions it may be taxed as software or TPP. Knowing what is being sold helps businesses come to correct taxing determinations.  

How is it being delivered?

The method of delivery is also an important consideration. States may have various requirements for taxation, dependent on the delivery method. In some states, the method of delivery can drastically affect taxability, while delivery methods may have no impact at all in other states. Organizations need to know how their software or digital goods are delivered to their customers and the rules that apply in the states where they transact business. 

Sales tax continues to evolve

Overall, businesses selling software (especially SaaS offerings) or digital goods need to keep up-to-date on sales tax requirements. An organization may understand the taxability of digital goods in some states, but those exact definitions – while informative – may not apply in other jurisdictions. Assuming that sales tax requirements on software or digital goods are always the same can be a pitfall. 

A software business could understand how taxes apply to digital goods they’ve been selling in certain states, but maybe now that business has economic nexus in more states due to South Dakota v. Wayfair, Inc. Those additional states may have vastly different rules that apply to software or digital products from those states you originally sold to.  

Software and digital goods have come a long way, and states are catching up to applying tax to technology products. That’s why it’s essential for businesses in the software industry to remain vigilant and know how the states in which they sell may have started to equitably apply sales tax to those types of products.

Take Action

Check out our recent webinar with Bennett Thrasher to learn more about the sales tax nuances for the software industry.

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Author

Erik Wallin

Erik Wallin is a Senior Tax Counsel on the Tax Research Team at Sovos Compliance. Erik has been with Sovos Compliance since 2011, and his main areas of focus are on U.S. Transaction Tax Law which includes special expertise in the taxation of technology and the taxation mechanisms that apply throughout the Colorado home rule jurisdictions. Erik is a member of the Massachusetts Bar, has a B.A. from York College of Pennsylvania, a J.D. from New England School of Law, and an LL.M. in Taxation from Boston University.
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