Sales Tax Compliance for Digital Goods and Subscriptions

Why this matters now

Sales tax rules for digital goods and subscriptions changed dramatically after the U.S. Supreme Court’s decision in South Dakota v. Wayfair, Inc. (2018), which allowed states to require out-of-state sellers to collect sales tax based on economic “nexus” rather than a physical presence. Since then, states have continued to update rules for software, streaming, e-books, online courses, and recurring subscription services.

In my 15 years advising small businesses and SaaS companies, I’ve seen two recurring mistakes: (1) assuming intangible equals non-taxable, and (2) failing to track buyer location and sales thresholds. Both errors raise audit exposure and can create large back-tax liabilities.

Sources: South Dakota v. Wayfair, Inc., National Conference of State Legislatures (NCSL), Avalara.

How states decide whether a digital product is taxable

Sales tax is a state (and sometimes local) tax. There’s no federal sales tax. Each state defines taxable goods and services and applies sourcing rules to determine which jurisdiction’s rate to use.

Key determinations a business must make:

• Product classification: Is your offering a taxable tangible service, a digital good, or a tax-exempt service? States treat prepaid digital downloads, streamed content, SaaS, and electronically delivered software differently. For example, some states tax downloaded software but exempt custom software or certain educational content.
• Nexus: Do you meet the state’s economic nexus thresholds (commonly $100,000 in sales or 200 transactions, though thresholds vary)? Check each state’s rules before assuming registration isn’t required (see state resources and the NCSL summaries).
• Sourcing rules: Is the sale sourced to the buyer’s billing address, shipping address, or the point of use? Most states use destination sourcing for digital services, meaning tax is based on the customer’s location.
• Marketplace facilitator laws: If you sell through a marketplace (App Store, Amazon, Google Play), many states require the marketplace to collect tax on behalf of third-party sellers. Don’t assume marketplaces handle every transaction—verify by state and marketplace.

For a deeper primer, see our guide on Sales Tax on Digital Products: What Remote Sellers Must Know.

Step-by-step compliance checklist

Use this practical checklist to reduce risk. Implementing these items will also make audits easier to manage.

1. Catalog your products and delivery methods

• List each SKU or service and document whether it’s a download, streamed, accessed remotely (SaaS), or delivered via mobile in-app purchase.
• Note any bundled offerings (e.g., a course that includes physical materials). Bundles can be partially taxable.

1. Determine product taxability by state

• Research the state Department of Revenue guidance for each state where you have customers. Taxability can vary widely so treat every state as unique.

1. Run nexus and economic presence checks monthly or quarterly

• Track gross remote sales and transaction counts by state. Many companies cross nexus thresholds quickly once subscriptions scale.

1. Register where required

• If a state’s nexus rules apply, register for a sales tax permit before you begin collecting. Late registration exposes you to penalties.

1. Set up correct sourcing and rate application

• Configure your checkout and billing system to capture the required customer location data (billing address, IP address, or primary place of use) and apply the correct tax rate (state + local).

1. Collect and store exemption documentation

• If a customer claims exemption (resale certificate, government/nonprofit status), collect valid forms and keep them on file according to state retention rules.

1. File and remit on schedule

• Filing frequency depends on expected tax liability and state rules. Missing a filing triggers penalties and interest.

1. Keep detailed records

• Maintain invoices, transaction logs, and certificates for at least the period required by the state (commonly 3–7 years).

1. Consider voluntary disclosure agreements (VDAs) if noncompliant

• If you discover past non-collection, many states offer VDAs that cap lookback periods and reduce penalties if you proactively engage.

1. Automate where feasible

• Tax engines and accounting integrations reduce calculation errors and simplify multi-state compliance. See our piece on Navigating Multi-State Sales Tax Registration for SaaS Businesses.

Special issues for subscriptions (recurring billing)

Subscriptions create additional traps:

• Timing and proration: Some states tax at sale initiation; others tax each renewal. Configure billing systems to apply tax consistently, including proration on upgrades/downgrades.
• Free trials and promotions: If a customer pays after a free trial, determine if the charge is taxable and start collecting levies at the time revenue is recognized in that jurisdiction.
• Cancellations and refunds: Keep clear refund records. States differ on whether you can retain previously remitted tax on refunded amounts.

SaaS, hosted software, and API charges—what to watch for

States disagree on the taxability of SaaS. Some treat SaaS as a taxable software/service, while others exempt it. If your product includes on-premise components, maintenance, or customization, break out charges on invoices to support tax positions during audits.

If you’re a SaaS provider selling nationally, read up on nexus rules and consider our guidance on State Sales Tax Nexus for Online Sellers: Establishing and Managing Obligations.

Marketplace facilitators and platform sales

Since 2019 most states enacted marketplace facilitator laws requiring marketplaces to collect and remit tax on behalf of third-party sellers. However, rules vary by state and by what the marketplace reports to sellers. If you use a marketplace, confirm whether the platform remits tax for your sales and whether you must still register for reporting or use tax obligations.

Avalara and state DOR guidance are good resources to confirm marketplace responsibilities.

Recordkeeping, audits, and common red flags

Maintain a tidy audit trail: customer address, invoice, how tax was calculated, any exemption certificates, and proof of delivery or service. Common audit triggers include:

• Large numbers of out-of-state sales without registration
• Inconsistent invoicing or bundled charges
• High-dollar refunds with missing documentation

If audited, produce your records promptly and consult a CPA or tax attorney. You may be eligible for voluntary disclosure to limit back-tax exposure.

For preparation steps see: “Preparing a Business for a State Sales Tax Audit: Records and Common Issues” (FinHelp glossary).

Penalties, interest, and voluntary disclosure

Penalties and interest differ by state. If you discover prior noncompliance, many states offer voluntary disclosure agreements (VDAs) that limit the lookback period (for example, to 3 years) in exchange for paying back taxes and agreeing to comply going forward. Contact each state’s Department of Revenue or a tax professional before filing a self-audit.

International sales: VAT and foreign obligations

U.S. sales tax generally does not apply to non-U.S. customers, but foreign VAT, GST, or digital service taxes often do. The EU and other jurisdictions have special rules for digital services (for example, VAT MOSS / One-Stop-Shop). If you sell internationally, consult cross-border VAT experts and local tax authorities.

Practical tools and best practices

• Use an automated tax engine (Avalara, TaxJar, Sovos) that integrates with your billing and e-commerce stack.
• Run monthly nexus and sourcing reports.
• Standardize invoices so product lines and tax treatment are clear.
• Train customer service to capture correct billing addresses and exemption claims at sale.

Final checklist for immediate action (30/60/90 days)

30 days:

• Catalog products and identify top 10 states by revenue.
• Confirm whether marketplaces remit tax for your transactions.

60 days:

• Register in states where nexus threshold is met.
• Configure billing systems to collect correct tax.

90 days:

• File initial returns, archive exemption forms, and run an internal compliance review.

Professional disclaimer

This article is educational and does not replace professional tax, legal, or accounting advice. State rules change frequently—consult a CPA or tax attorney for guidance tailored to your business, and check state Department of Revenue websites for the latest rules. See authoritative sources including the U.S. Supreme Court decision South Dakota v. Wayfair, Inc. and summaries from the National Conference of State Legislatures (NCSL) and Avalara.

If you want, I can prepare a customized nexus-check spreadsheet or a prioritized state-registration plan based on your customer ZIP code history. In my practice, a simple monthly automation rule that flags states crossing $50,000 in trailing 12-month gross revenue catches most surprises before you hit mandatory thresholds.