Quick overview

States differ widely on whether and how they tax digital products. After the 2018 U.S. Supreme Court ruling in South Dakota v. Wayfair, states can require remote sellers to collect sales tax when they meet economic nexus tests (often based on sales dollars or transaction counts), even if the seller has no physical presence in the state (SCOTUS, Wayfair decision).

This article explains the core concepts remote sellers need to evaluate, practical steps to determine obligations, common traps, and recommended compliance workflows.

Why sales tax on digital products matters for remote sellers

  • Revenue risk: Uncollected sales tax plus interest and penalties can be material for a growing digital business.
  • Administrative complexity: Each state (and some local jurisdictions) sets different rules about what counts as a taxable digital product and how to calculate the rate.
  • Marketplace rules: Marketplace facilitator laws shift collection responsibility in many cases, but the seller may still need to register or report sales data.

In my 15 years advising online businesses, I’ve seen modest sellers face multi-thousand-dollar liabilities after a state audit because they underestimated where their products were taxable. Treat sales-tax compliance as an operational task, not a one-time setup.

Key concepts remote sellers must understand

  • Economic nexus: After Wayfair (2018), most states impose economic nexus — commonly a threshold such as $100,000 in sales or 200 transactions to in-state customers in a 12-month period — but exact thresholds vary. Always check the state statute or revenue department guidance for current thresholds (Tax Foundation; Avalara).

  • Sourcing (where a sale is taxed): For most states, the sale of a digital product is sourced to the buyer’s location (destination-based sourcing). Some states use origin-based sourcing for certain sales. Verify the sourcing rule for each state where you sell.

  • Product classification: States classify digital items differently. Examples include: downloadable goods (ebooks, software), streaming (music, video), digital subscriptions, SaaS, and access to online courses. A product taxed in State A may be exempt in State B. See state guidance and private letter rulings for detail.

  • Marketplace facilitator rules: If you sell through marketplaces (Amazon, Etsy, Apple App Store, etc.), many states require the marketplace to collect and remit tax on behalf of third-party sellers. Even then, sellers should track marketplace-collected sales and confirm registration requirements for reporting.

  • Exemptions and resale: Some B2B sales, sales to tax-exempt organizations, or transactions where the buyer provides a valid exemption/resale certificate may not be taxable. Maintain documented exemption certificates and validate buyers when appropriate.

How to determine your sales tax obligations for digital products

  1. Inventory your products and delivery methods
  • Create a product map that describes whether the item is a download, streamed service, subscription, or SaaS access and whether the purchaser receives a file or only access.
  1. Map where your customers live
  • Use your sales records to identify states (and large local jurisdictions) where you have customers. Economic nexus is triggered by buyer location, not seller location.
  1. Check each state’s rules
  • For each state with buyers, review that state’s department of revenue guidance for digital products, nexus thresholds, and sourcing rules. State revenue sites and guides from vendors like Avalara and TaxJar summarize these rules but confirm with the state directly.
  1. Determine who collects the tax
  • If you sell via a marketplace, confirm whether the marketplace facilitator collects and remits tax for your sales there. If you sell direct, you are typically responsible once you meet nexus thresholds.
  1. Register, collect, and remit
  • If you must collect, register for a sales tax permit in that state, collect tax at the correct rate (accounting for local add-ons), file returns on the required schedule, and remit collected tax.
  1. Maintain documentation
  • Keep exemption certificates, resale certificates, and evidence used to determine sourcing. Documentation reduces audit risk and helps substantiate compliance decisions.

Practical compliance checklist (step-by-step)

  • Run a 12-month sales analysis to identify states where you exceed economic nexus thresholds.
  • Classify every product by the state’s definition (download, subscription, SaaS, etc.).
  • Confirm marketplace facilitator status for channels you use and reconcile platform-collected tax reports with your sales ledger.
  • Register for a sales tax permit before you begin collecting in that state.
  • Implement tax calculation in your checkout flow using a reliable tax engine to apply correct rates and taxability rules.
  • File timely returns and maintain a schedule for periodic reconciliation, even for states where tax is collected by a marketplace.

Technology and automation

Automated tax engines reduce errors, apply state-specific taxability rules, and handle local jurisdiction rates and remittance filings. Options range from turnkey services (Avalara, TaxJar, Sovos) to platform-integrated tools that plug into Shopify, Stripe, or your custom checkout.

If you sell across many states, automation is not optional: manual rate lookups and exemptions create high operational risk. See our guide on implementing automation for practical vendor selection and integration tips (FinHelp: How to Implement Sales Tax Automation for Small Businesses).

(Internal link: How to Implement Sales Tax Automation for Small Businesses — https://finhelp.io/glossary/how-to-implement-sales-tax-automation-for-small-businesses/)

Common mistakes and how to avoid them

  • Assuming all digital goods are treated the same: States draw different lines between taxable and nontaxable digital items. Always verify the category for each product.
  • Ignoring small-dollar sales: Economical thresholds can be reached quickly with subscription models; monitor rolling 12-month sales regularly.
  • Over-relying on marketplaces without reconciliation: Marketplaces may collect tax, but sellers should reconcile and keep registration records.
  • Poor recordkeeping: Missing exemption certificates or incomplete sourcing evidence increases audit exposure.

Examples and case notes (practice-based insights)

  • Online course provider: A client who sold self-paced online courses thought their home-state rules governed them. After selling to students in several states, they exceeded thresholds for two states that tax access to digital educational content. We registered in those states, retroactively collected where possible, and negotiated a payment plan for prior liabilities during voluntary disclosure.

  • SaaS business: I advised a SaaS firm that believed its software-as-a-service offering was not taxable. After reviewing state guidance, we identified three states that tax SaaS; we implemented a tax engine and revised invoices to break out tax, improving transparency for customers and authorities.

These real-world situations underscore why sellers should evaluate product classification and monitor customer location by state.

Frequently asked questions

Q: Do I need to collect sales tax if I’m in a no-sales-tax state?
A: Possibly. Sales tax collection is driven by buyer location and state nexus thresholds — you can owe tax to states even if your home state doesn’t impose sales tax.

Q: Are subscriptions treated differently than one-time downloads?
A: Yes. Some states tax recurring access or streaming differently from permanent downloads; others tax both. Check each state’s guidance.

Q: What if a marketplace collects tax on my behalf?
A: Many states relieve third-party sellers from collection responsibility when the marketplace facilitator collects, but sellers often still must register or report gross sales. Confirm the specific state rule and maintain records.

Resources and authoritative references

  • South Dakota v. Wayfair, Inc., 585 U.S. ___ (2018) — U.S. Supreme Court ruling on economic nexus.
  • Streamlined Sales and Use Tax Governing Board — resources on uniform rules (https://www.streamlinedsalestax.org).
  • Tax Foundation summaries of state thresholds and rules (https://taxfoundation.org).
  • Vendor guides (non-governmental): Avalara and TaxJar maintain state-by-state taxability lists and practical guidance (https://www.avalara.com; https://www.taxjar.com).
  • State Departments of Revenue — primary source for current taxability and registration information (search “[State] Department of Revenue digital products”).

(For general federal tax questions see IRS at https://www.irs.gov; consumer guidance at https://www.consumerfinance.gov.)

Final professional tips

  1. Treat taxability review as part of product launches: Add a tax-review step before new digital product offerings go live.
  2. Use a three-way match in bookkeeping: sales records, payment processor reports, and tax engine logs to uncover inconsistencies quickly.
  3. Consider voluntary disclosure if you discover past non-compliance — states often offer reduced penalties when businesses come forward proactively.

Professional disclaimer: This article is educational and does not constitute legal or tax advice. State laws change regularly; consult a qualified tax advisor or the relevant state revenue department for guidance tailored to your business.

Authorship: Written by a tax compliance practitioner with 15 years’ experience advising digital sellers.© FinHelp.io