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How States Are Avoiding Square-Peg Tax Policies for Technology

Aug. 10, 2022, 8:45 AM

States tend to be five years or more behind new sales tax developments. Once appropriate guidance is enacted on a new topic, the issues that were sought to be addressed have often morphed into something completely different.

In addition to creating an ever-changing game of catch-up by states, this environment also forces taxpayers and tax practitioners to apply square-peg tax guidance to evolving round-hole technology. To combat this, many states have created tax laws that are as broad as possible to address technological and societal developments. This is especially true of digital goods and digital products. Approximately 31 states impose sales tax on digital goods and products in some way.

Perhaps the threshold issue in this area is defining what the terms digital goods and digital products actually mean. As with most things in state tax, the answer is that it depends. While some states have detailed definitions of these terms, others merely have sought to impose taxation through regulation or some type of informal guidance.

Historically, many states took the position that if something was taxable when sold in a tangible form, such item remains taxable if sold in an electronic form. A Colorado ruling states: “Digital documents, as is true of digital photographs, music, books, movies and newspapers, have a physical existence and are no less taxable than had they been delivered in paper or celluloid form.”

Pennsylvania’s Approach

When the internet and digital products first became more commonplace, some states attempted to statutorily enumerate those items it sought to tax. Pennsylvania took this approach, specifically enumerating the following items as taxable tangible personal property regardless of how accessed or delivered: videos, photos, books, apps, games, music, and “any other otherwise taxable tangible personal property electronically or digitally delivered.”

Clearly, updating this list as new technology is developed can be somewhat onerous. This could be the reason why when it came to non-fungible tokens, as opposed to adding to the statute, Pennsylvania merely added NFTs to its listing of taxable items via publication in a bulletin. Presumably, NFTs fall under the statutory wording regarding “any other otherwise taxable tangible personal property electronically or digitally delivered.”

Maryland in the Lead

Maryland is taking a lead in digital product taxation, although it has experienced its own struggles. In 2021, the state passed H.B. 732, imposing a new tax on digital advertising services; and H.B. 932, which expanded sales and use taxation to certain digital products. Its digital advertising services tax is the first of its kind in the country, but it is facing various challenges.

Maryland’s legislation taxing digital products includes examples of what constitutes digital codes and digital goods as well as the following fairly broad definition of a digital product: “A products that is obtained electronically by the buyer or delivered by means other than tangible storage media through the use of technology having electrical, digital, magnetic, wireless, optical, electromagnetic or similar capabilities.” This definition appears broad enough to encompass almost anything sold via other than tangible means and is a trend among states: to list what you can and include definitions broad enough to encompass new or developing technologies.

To provide further guidance, Maryland issued Tax Tip #29—Sales of Digital Products and Digital Codes. Its details include examples as to what constitutes a digital product: static, non-customized information reports, electronic chat rooms, weblogs and similar products, stock photos, and artwork. Interestingly, Maryland includes Software as a Service, or SaaS, within the definition of digital products, while many states define digital products apart from SaaS. Maryland then provides several SaaS-related exemptions, including one for customized software.

When Maryland’s guidance regarding the customized exemption for SaaS first came out, there was some confusion regarding how broad this exemption was, specifically how much customization was required for the exemption to apply. Any software other than purely plug-and-play software is deemed to be customized and potentially falls under the exemption for customized software. Further, partly due to this confusion, Maryland amended the definition of what constitutes taxable SaaS and enterprise software, expanding the exemption for commercial software.

New Jersey and New York

New Jersey’s taxation of digital products is more limited than Maryland’s. New Jersey only taxes specified digital products, which include “electronically transferred digital audio-visual work, digital audio work or digital books.” A digital audio-visual work is “a series of related images which, when shown in succession, impart an impression of motion, together with accompanying sounds.” A digital audio work is “a work that results from the fixation of a series of musical, spoken or other sounds, including a ringtone;” and a digital book is “a work that is generally recognized in the ordinary and usual sense as a book.”

Thus, it appears New Jersey takes a more limited or traditional approach to the taxation of digital goods, essentially taxing those items in the digital realm that are taxable in the physical realm. New Jersey also does not generally tax SaaS, deeming it to be more of an exempt service.

While New York is very aggressive in its taxation of SaaS and any type of electronically-delivered software as well as information services, this is not the case when it comes to digital products. Generally, digital products such as ringtones, ebooks, movies, and music are not subject to sales tax in New York.


States have taken diverse approaches to the taxation of digital products, and this area continues to evolve. As such, we can continue to see states reacting to new technologies and the real or perceived loss of revenue associated with the growth of digital products. While it would be great to hope for states to achieve some sort of uniform approach here, this is likely unrealistic for the immediate future.

However, we can hope that states fully examine the ramifications of new legislation and carefully craft tax bills to achieve clarity plus intended revenue purposes. Clear definitions of what is taxable and what is exempt will go a long way toward alleviating taxpayer angst surrounding the taxation of digital products—even in the absence of state uniformity.

This article does not necessarily reflect the opinion of The Bureau of National Affairs, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.

Author Information

Gary C. Bingel is partner-in-charge for state and local taxes in EisnerAmper’s State and Local Tax National Tax Group.

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