In recent years, we have seen a steady increase in the sale of digital products, including music, movies, video games and books. Obviously, as sales of products in digital form increase, the sale of the same in tangible form – CDs, DVDs and paper books – decreases.
Because we received MP3 players for the holiday and loaded up on music, recent figures indicate that the week after Christmas 2009 recorded the largest one-week sales of music downloads ever. Amazon’s Kindle eBook device remained a hot seller this past year as well, driving the sale of downloaded books to all-time highs.
As the sale of digital downloads increase, the resulting reduction in the sale of tangible products has far reaching implications for the state tax coffers and already-strained state budgets.
Currently, states can tax digital downloads under one of two approaches:
1. The state applies existing law and definitions to apply the tax. Included in this approach are Alabama, Arizona, Colorado, Indiana, Louisiana, Maine, New Mexico, Texas, Utah and West Virginia.
2. The state passed legislation explicitly applying sales tax to digital downloads. States passing specific legislation include Idaho, Kentucky, Nebraska, New Jersey, South Dakota, Tennessee, Vermont, Washington and Wisconsin.
Only North Dakota and Washington, D.C. have laws that expressly exempt the sale of digital downloads from sales tax.
Most notably missing from these lists are several of the largest states in terms of population, including California, Florida, Illinois, New Jersey, New York and Pennsylvania. However, these states and many others continue to face large budget deficits. The opportunity to add digital downloads to the tax base is likely to be given serious consideration by the various legislative bodies.
The Streamlined Sales Tax Project (SSTP), which includes 20 states as full members, recently spent significant time addressing the issue of digital downloads, mainly from the standpoint of trying to determine how to “define” them. Even though member states still have to pass legislation specifically addressing the taxation of digital downloads, they will walk away with a uniform definition.
As more and more consumers purchase goods and services over the Internet, state tax bases continue to erode, and the state of the economy continues to take a toll on state budgets, we will likely see many more states pass legislation to assess sales tax on digital downloads.
Pat McCown, CPA, is a partner in the State and Local Tax (SALT) practice for Lane Gorman Trubitt, LLP in Dallas, Texas. He has more than 15 years’ experience in multi-state tax planning, audit representation, refunds and consulting. His client includes manufacturing, oil and gas, transportation, high-tech, healthcare and telecom industries. Contact him at 214.461.1416 or email@example.com.