Sales Tax Rules for Digital Goods: What Businesses Must Know

Introduction

Sales tax for digital goods is one of the fastest-changing areas of state tax law. Since the Supreme Court’s decision in South Dakota v. Wayfair, Inc. (2018), states have enacted economic nexus standards, marketplace facilitator rules, and specific taxability definitions that affect online sales of digital content, software, subscriptions, and streaming. For businesses selling digital products nationwide, getting the rules right reduces audit risk, avoids back taxes and penalties, and improves pricing transparency for customers.

(Author note: In my experience advising software and publishing clients, early mapping of digital products to state tax categories and automating collection cut audit exposure and administrative burden.)

Why this matters now

• States have aggressively closed gaps in revenue from online and digital sales since 2018 (Wayfair).
• Many states now require marketplace facilitators (e.g., app stores, platforms) to collect and remit sales tax — shifting compliance responsibility in many transactions.
• Digital product taxability and sourcing rules are not uniform: a product taxable in one state may be exempt in another.

Authoritative guidance: Supreme Court, South Dakota v. Wayfair, Inc., 2018; state Departments of Revenue and the Tax Foundation provide state-level summaries (see sources at end).

How the rules work — the core components

1. Product taxability

• States classify digital goods differently. Typical categories include digital downloads (ebooks, music), streamed content, prewritten (canned) software, custom software, and SaaS.
• Examples: Some states tax downloaded movies and music; others exempt certain digital publications or educational materials. SaaS is particularly variable: some states treat it as a taxable service, others as nontaxable intangible property.
• Action: Create a product taxability matrix mapping each digital SKU to state rules. Start with your highest-volume states.

1. Nexus (why you may owe tax in a state)

• Nexus is the connection that gives a state authority to tax your sales. Post-Wayfair, economic nexus based on sales into a state is common. Typical triggers used by states include:
• Dollar thresholds (many states use $100,000 in sales),
• Transaction count thresholds (commonly 200 transactions),
• Affiliate, click-through, or marketplace-related activity that creates nexus.
• Thresholds vary by state; check each state’s statute or Department of Revenue guidance.
• Action: Monitor your gross taxable receipts and transaction counts per state and apply thresholds conservatively. When you hit a threshold, register and begin collecting.

1. Sourcing rules (where the sale is taxed)

• Sourcing decides which state’s rate applies. There are two common approaches:
• Destination-based sourcing: tax is applied based on the customer’s location (used by most states for remote sales).
• Origin-based sourcing: tax is based on the seller’s location (used by a few states for intrastate sales).
• For digital goods, many states apply destination sourcing, but some have special rules; verify each state’s sourcing rules.

1. Marketplace facilitator laws

• As of 2025, most states have marketplace facilitator laws requiring platforms (e.g., Apple App Store, Amazon, Google Play, software marketplaces) to collect and remit sales tax when they facilitate sales.
• This can relieve small sellers of collection duties when selling through major marketplaces, but sellers still need to understand reporting and potential registration responsibilities.

1. Exemptions and resale certificates

• Common exemptions include sales for resale (resale certificates), certain educational materials, or government purchases, but exemptions vary widely.
• Keep properly completed exemption certificates on file and validate certificates periodically.

Practical compliance checklist (step-by-step)

1. Inventory your products and classify each SKU (download, streaming, subscription, SaaS, custom software).
2. Build a state-by-state taxability matrix. Prioritize top 10 states by revenue.
3. Track sales and transaction counts by state to detect nexus thresholds.
4. Register for sales tax permits in states where nexus exists — do not wait for an audit notice.
5. Configure your checkout to collect tax based on the correct sourcing rule and product mapping.
6. File returns and remit collections on schedule; missing returns often trigger penalties.
7. Store exemption certificates and sales records (many states expect 3–7 years of records).
8. Reassess periodically and after product launches, ad campaigns, or marketplace changes.

Recommended systems and automation

• Tax engines: Consider automated sales tax tools (e.g., Avalara, TaxJar, Sovos) to map taxability, calculate rates, and prepare returns. Automation reduces manual errors and scales with growth.
• ERP/e-commerce integration: Ensure your tax solution integrates with your shopping cart, billing (subscription) system, and accounting software so invoices, returns, and remittance reconcile.
• Reporting: Generate state-level reports showing taxable vs exempt sales, marketplace vs direct sales, and exemption certificate logs.

Common pitfalls and how to avoid them

• Assuming uniform taxability: Don’t assume e-books, music, or subscriptions are taxed the same everywhere. Maintain the product taxability matrix.
• Ignoring marketplace rules: Even if a marketplace collects tax, you may still need to register or report in some states—confirm state guidance.
• Failing to monitor marketing and activity that creates nexus: Affiliate programs, targeted ad campaigns, and physical trade shows can create nexus.
• Mixing up sourcing rules: Charging tax based on your home state rather than the customer’s state can cause under- or over-collection.

Real-world examples (anonymized)

• SaaS provider: A B2B SaaS firm increased outbound sales and exceeded a $100,000 sales threshold in several states. After registering and starting collection, they avoided a multi-year liability by negotiating limited look-back periods with revenue departments and implementing automated tax calculation.

• Publisher: A digital publisher sold enhanced textbooks to students nationwide. State-by-state analysis showed educational exemptions in a few jurisdictions; after adjusting checkout rules and collecting resale/exemption certificates from institutional buyers, they reduced tax exposure and simplified pricing.

Audit preparedness and recordkeeping

• Keep invoices, transaction logs, exemption certificates, and tax returns organized and backed up.
• Typical retention requirements: many states expect 3–7 years; confirm each state’s statutory period. Response to an audit is faster and less costly with clear documentation.

Interaction with federal taxes and accounting

• Sales tax is a state and local tax — the IRS does not administer it. However, sales tax collected is a liability on your books; ensure your accounting shows collected tax separately and reconciles to returns.
• Sales taxes are not deductible as business expenses when paid as a seller’s liability; consult your accountant on tax treatment and reporting.

Frequently asked questions

Q: Are all digital downloads taxable?
A: No. Taxability varies by state and by type of digital good. For example, some states tax digital movies and music while others exempt certain publications.

Q: Is SaaS taxable?
A: It depends. Some states treat SaaS as a taxable service or tangible personal property; others do not. Classify SaaS features and compare to state definitions.

Q: Who collects tax on marketplace sales?
A: Many states require marketplace facilitators to collect and remit tax, but rules and thresholds vary. Sellers should confirm collection and reporting responsibilities for each marketplace and state.

Q: What triggers nexus besides sales amounts?
A: Physical presence, employees, inventory in a state (including marketplace inventory), affiliates or referral arrangements, and certain marketing activities can create nexus.

Q: Where can I find the tax rate for a customer’s state?
A: Use state Department of Revenue websites or a certified tax engine — remember local (city/county) surtaxes may apply.

Professional tips

• Start with states that drive your revenue. Register early rather than appealing retroactively — voluntary disclosure agreements with states sometimes reduce penalties for prompt registration.
• Use a conservative approach when thresholds are close; register and test for a short period instead of risking large back liabilities.
• Keep product descriptions stable. Minor catalog changes can alter taxability in certain states.

Internal resources

• For SaaS-specific guidance, see our article: Sales Tax Compliance for SaaS Businesses.
• For a state-by-state breakdown of digital product taxability, consult: State Tax Rules — Sales Tax Treatment of Digital Products: State-by-State Differences.
• To understand how nexus rules affect remote sellers, review: State Sales Tax Nexus for Remote Sellers: Establishing and Managing Obligations.

Sources and further reading

• Supreme Court of the United States, South Dakota v. Wayfair, Inc., 585 U.S. ___ (2018).
• Tax Foundation: state sales tax summaries and analyses (see taxfoundation.org).
• State Departments of Revenue: consult the revenue department or tax code for each state where you sell.
• Streamlined Sales and Use Tax Governing Board (streamlinedsalestax.org) for information on simplified rules used by participating states.

Disclaimer

This article is educational and informational only and does not constitute legal, tax, or accounting advice. State rules change frequently; consult a qualified tax professional and the relevant state Department of Revenue for guidance tailored to your business and transactions.