Estimated read time: 4 minutes, 31 seconds
Software and digital products are changing the way we live in drastic ways. Just about everyone interacts with digital products at some point in their day—obviously some more than others. However, this means the software market in the United States is a very lucrative and competitive landscape. In fact, the software market revenue in the United States is expected to exceed $200 billion dollars by 2021.
While there is a lot of money to be made, one of the biggest challenges of selling digital products in the United States is navigating the intricate tax system. So, let’s talk about how current U.S. tax laws work.
United States Sales Tax
Sales tax in the United States is complex. And it gets even more complicated when you throw in crazy stuff like “digital goods and services.” When sales tax laws were originally written, they were for the purpose of regulating physical items—things that could be weighed, packaged, and delivered.
Despite the prevalence of online goods and services, our sales tax laws are still based on the original statutes that apply to tangible goods.
Now, let’s take it one step further. Here are ways states apply sales tax laws differently:
- Definitions and terms are not universal
- Treatment of particular services varies
- Source of services is unknown
- States use a variety of different methods to determine how to tax tangible goods sold with a service
While there is the Streamlined Sales Tax (SST), which is a voluntary organization of 22 states that seeks to create uniformity among states with regard to sales tax and compliance obligations, there is still a lot of ambiguity. For example, states have different definitions for “digital products.” Which leads us to our next point …
What are Digital Products?
The SST has three main categories of “specified digital products,” which means products that are digitally transferred:
- Digital video files – television shows or movies
- Digital audio files – music and podcasts
- Digital books – books delivered without physical media
As you probably noticed, many digital products are not represented in the SST definition. Essentially, it only applies to Netflix, iTunes, and Audible. So, digital goods like data processing, computer software, and other online (cloud) services still live in an undefined area of U.S. state tax law.
Regardless of varying definitions, your online business still needs to be tax compliant. So, here are some ways to keep your business on the up-and-up.
Collection and Remittance
“Sales tax (aka retail sales tax) is a transaction tax imposed by states and thousands of local jurisdictions on the sale of a product or service from a seller to a consumer. Since it would be costly and awkward for states to station a tax collector in every shop, the task of collecting sales tax falls on the businesses that make the sales.”
Translation: Businesses are responsible to collect sales tax for the states in which their business and customers are located. So, if their customer is located in a state other than where their business is located, they need to collect sales tax for both states.
If you sell your digital goods outside of the U.S., you are responsible for “value-added tax” (VAT). Essentially, anytime a person outside of the U.S. (specifically the EU) purchases your digital product, your business holds onto a portion of the sale to later pay to the government.
Here are some quick tips to stay VAT compliant:
- Identify your customers and their physical location
- Determine location-based VAT rates and charge them when applicable
- Keep detailed transaction records
- Report VAT
Current Sales Tax Rates in the United States
Here are the current sales tax rates for the U.S.:
- Alabama – 8%
- Arizona – 8.6%
- California – 7.25%
- California: San Francisco – 8.5%
- California: Santa Barbara – 8.75%
- Indiana – 7%
- Maine – 5.5%
- Massachusetts – 6.25%
- Nebraska – 7.25%
- Pennsylvania – 6%
- Rhode Island – 7%
- South Dakota – 6.5%
- Tennessee – 0%
- Texas – 8.25%
- Vermont – 6%
- Wyoming – 0%
And here are the current VAT rates for foreign countries:
- Australia – 10%
- Austria – 20%
- Belgium – 21%
- Bulgaria – 20%
- Switzerland – 7.7%
- Cyprus – 19%
- Czech Republic – 21%
- Denmark – 25%
- Germany – 19%
- Estonia – 20%
- United Kingdom – 20%
- Greece – 24%
- Spain – 21%
- Finland – 24%
- France – 20%
- Croatia – 25%
- Hungary – 27%
- Republic of Ireland – 23%
- India – 18%
- Italy – 22%
- Japan – 8%
- Lithuania – 21%
- Luxembourg – 17%
- Latvia – 21%
- Malta – 18%
- Netherlands – 21%
- New Zealand – 15%
- Norway – 25%
- Poland – 23%
- Portugal – 23%
- Romania – 19%
- Russia – 0%
- Sweden – 25%
- Slovenia – 22%
- Slovakia – 20%
- South Africa – 14%
- South Korea – 10%
- Taiwan – 5%
Who is tax-exempt?
There are two main scenarios in which you could be tax-exempt:
1. If, as a VAT registered business, you sell your goods or services to another VAT registered business
2. If your services provide a public good or aid the public interest – E.g. Education to children or young people, vocational training or retraining, hospital or medical care or closely related activities
To recap, we have a bunch of old laws that weren’t written for digital goods that now regulate the sale of digital goods. We have 50 different states and countless other countries with different tax rates and tax laws. And we don’t have a standardized definition for “digital goods”
across all players involved.
At this point, if you’re thinking, “This is too complicated. I don’t want to have to figure this out,” that’s okay. You don’t have to figure this out by yourself, because other people—more qualified people—already have.
Services, like FastSpring, exist to make sure you don’t have to deal with the intricacies of local, state, and international tax policies. We provide end-to-end ecommerce solutions that are designed to help you sell software, content, and other apps online without the tax headache. You create an awesome digital product, and we make sure your transactions are compliant.