This guest post is brought to you by CPA Chris Peden of the Accounting Scribe.
The world has changed in the years since you could get twelve records for a penny. It used to be that if you were a business owner, you would have to include in an amount for sales tax on an invoice when you sent a customer your product. You would then send that amount to your city or state, and have to keep good records as far as what you charged to who for what.
But things are different now. No longer is essentially all revenue generated from selling goods and services. Thanks to advances in technology, you now have digital goods that can be bought and sold with just a click on a website. But do you have to pay sales tax on these digital goods? After all, you didn’t actually sell a physical book to someone, just a somewhat random collection of bytes and bits?
What is a digital good?
When it comes to sales tax, most definitions vary from state to state. But to make thing easier, in 2000 the Streamlined Sales Tax Governing Board was formed to provide a uniformed definition of digital goods, and to push for alignment of sales tax regulations across states and other jurisdictions in the United States. They don’t require states to tax sales at a certain rate or determine what states may tax, but they work with states to unify the definitions of the types of things that are taxable and ways to increase the efficiency of how sales tax is reported and collected.
They have defined digital goods as:
- Digital Audio-Visual Works – these are comprised of things that are akin to a movie or video, with a set of images shown in succession with sounds accompanying the images;
- Digital Audio Works – these are made of a sounds, which may include voice, music, a combination of the two, and would include such thing as ringtones;
- Digital Books – as the name implies, are basically books that are in an electronic format.
The big problem is that while the Streamlined Sales Tax Governing Board is currently made up of twenty-two states, there are twenty-three other states (plus the District of Columbia) that have their own rules and regulations about sales tax. Some of these states have passed laws setting forth how digital goods are to be taxed, while other legislatures in other states have given this power to a state agency under the direction of its governor. There is a good bit of difference between how the different states tax digital goods, so what may be taxed at one rate in one state may be entirely different from the sales tax rules in other states.
One thing that has helped in making it easier for business owners to comply with sales tax laws was the U.S. Congress passing the Digital Goods and Services Tax Fairness Act of 2011. This was meant to ensure that the states did not go outside their already established framework for the application of sales tax laws. As a result of the passage of this act, the states that already tax digital goods have not added addition types of sales taxes that business will have to collect and remit to the various state governments.
So, you know what digital goods are, and that different states have different laws and regulations. However, how do you know if you need to pay taxes in a state? Do you have to sign up for a sales tax license from every state in case you do business there?
Thankfully, you do not have to sign up for a sales tax license in every state. You will only have to register for a sales tax license in a state where you have sales tax nexus. A nexus, in a tax perspective, means that your business has established a presence in an area. This could be a presence in a state, or possibly in a county or city if the state has sales taxes determined at that level of government.
To establish a presence, you can either have a direct presence, such as having a store or office in the area, or a presence through a representative who is located in that particular jurisdiction, hold inventory within that state, or have employees who live or work in that jurisdiction. In additionally, you can establish a nexus if you have affiliates in that state whosell your goods. Keep in mind that a nexus can be established if you have people traveling through the state to visit actual or potential customers, or to attend trade shows. If you have established either a permanent or temporary presence by doing these things, you may have established a nexus and need to register as a retailer and get set up to collect sales tax.
What should a business owner do about sales tax on digital goods?
Now that you know the basics about sales tax for digital goods, what should you as a business owner do? The first thing to do is Contact your state department of revenue. You will want to talk to them to get the definition of what would be considered digital good subject to sales tax in that state. Additionally, find out from them if you will need to register at the city or county level as some states, such as Arizona, charge sales tax at that level.
Next, once you have a good understanding of the rules you need to follow, is apply for a license to charge and collect sales tax. Do not start charging sales tax until you have a license to do so. Like a license to practice law or medicine, it is unlawful to charge or collect sales tax if you do not have a license. However, keep in mind that failing to register to collect sales tax does not exempt you from the obligation to charge and remit sales tax, so the best thing to do is register.
Lastly, if you have any question about sales tax laws in your state, contact an accountant in your state who understands the rules and can help you navigate the various rules and regulations.
Have questions or comments? Start the conversation in the comments below.
About the Author:
Chris Peden, CPA, CMA, CFM has spent more than 15 years in the corporate world helping companies meet their regulatory compliance requirements. He also assists small business owners with organizing and making sense of their finance information.