Sales tax for digital products is a dynamic and in many cases, confusing topic for online sellers. Understanding the basics can help you to determine when to collect sales tax to be compliant with tax laws.
This guide will help to provide a foundation for RD2RD vendors regarding sales tax. In addition to answering common questions and providing links to resources, it will show you how to obtain customer order details from your vendor dashboard.
Sales Tax Basics for Digital Products
Take a deep breath. The topic of sales tax can feel daunting, especially when you’re talking about digital products.
Digital products are much different than physical products. For example, think about the difference between selling a traditional book versus an ebook. One is tangible property while the other is a digital download. What about an ebook rental or subscription service?
Part of the challenge with sales tax for digital products is that the rules and laws don’t reflect how modern eCommerce works. Rules used for catalog sales are often the basis for determining digital product taxability.
However, this is changing. There is a considerable amount of action being taken by states regarding sales tax for online sales including digital products. If you’re not familiar with the terms, economic nexus and remote sellers, they should now be on your radar.
The primary reason for these changes is that as consumers have moved to shopping online, sales tax revenue from brick and mortar stores has decreased. Updating tax law helps states capture more in sales tax revenue and make sure that both sellers and customers are treated more fairly.
You need to be paying attention to changes in tax laws that impact you.
Researching the topic of sales tax online is an excellent way to better understand the basics, but isn’t a substitution for the expertise of a tax professional. Be sure to discuss your specific situation with a knowledgeable expert.
Do I need to collect sales tax?
The answer is complicated. This is often where most online sellers get stumped. An important term to understand when it comes breaking through the confusion is “nexus.”
Explained in simple terms, your nexus is the state(s) that your business has a connection to. For example, maybe you have offices in two different states or an employee in another state. A detailed explanation of sales tax nexus can be found here.
If you have a nexus in a state, you may need to collect sales tax for purchases made by customers in that state.
You may need to contact the tax authority for each state (often called the Department of Revenue) to confirm if you have a nexus. Each state sets their own rules in regards to sales tax including nexus, required registration/permits and which products are taxable.
Are you still with me? Don’t stop now. This topic will get a lot less muddy when you just dig in and think about your specific situation.
Are Digital Products Taxable?
The answer depends. About 65% of states have some definition of digital goods for sales tax purposes.
Once you’ve determined your sales tax nexus, the next step is to determine the specific rules for sales tax for the products you sell. Some states have no sales tax, don’t tax digital products, have a specific definition digital products for tax purposes or apply rules for other taxable items.
This detailed article from TaxJar gives an excellent overview of the topic and specifically lists state-by-state resources.
To keep from getting caught up in confusion, stay focused on the specific digital products that you sell and determine if it is taxable in your nexus.
Example Scenarios for Sales Tax on Digital Products
The examples below are simplified and for demonstration purposes only. A tax professional experienced in ecommerce could provide you with specific details about your requirements.
Example 1: Let’s assume that you live and operate your business in Oregon. You have no nexus in any other state. Oregon is one of the six states that has no sales tax (physical or digital goods). This would mean that you have no requirement for sales tax for your digital product sales.
Example 2: You live and operate your business in California. You have no nexus in any other state. California has sales tax, but digital products are exempt from sales tax. This would mean that you have no requirement for sales tax for your digital product sales.
Example 3: You live in Washington state. You have no nexus in any other state. Washington has sales tax and digital products are subject to sales tax (including downloaded, streaming and subscription). This would mean that you have a requirement to collect and remit sales tax for purchases made by customers in Washington state.
Example 4: You live in Washington state and also have an office/employees in California. Your business has a nexus in two states. For digital products, you would have a requirement to collect and remit sales tax for purchases made by customers in Washington, but not for customers in California .
As you can see from these examples, sales tax can be complicated. When you take things step-by-step and apply the basic concepts to your specific business and products, you can get on top of this important aspect of selling online.
Remote Seller Sales Tax Considerations
If you are a sell digital products on a marketplace like RD2RD, you should be paying close attention to changes in rules for remote sellers. Specifically, new rules in regards to economic nexus.
A landmark Supreme Court case (South Dakota vs Wayfair) was decided in 2018 in favor of the states ability to collect sales tax from remote sellers. Other states have quickly followed up with changes to their tax rules.
This is an excellent resource describing remote seller concept. To get into the details about state-by-state requirements, this resource offers a clickable table.
How do I collect and remit sales tax for digital product?
Determining which customers to tax and for which products is only part of the challenge with sales tax for digital products.
When necessary, sales tax is collected from the purchaser at checkout. Typically, most ecommerce tools have sales tax setting. You can specify which products are taxable and the rate to charge customers based on their location.
Check with each states’ tax authority (often the Department of Revenue) to determine if there is a specific threshold for sales ($ or number) and how to apply/register for a sales tax permit. You don’t want to be collecting sales tax without a permit to do so.
Inclusive vs Exclusive Pricing
When pricing your products, you also must choose if you will select a price that includes tax or if tax will be added. The simplest approach is to use inclusive pricing. All customers are charged the same amount. However, this does mean there will be an impact on your product margin for sales.
In practical terms, an inclusive pricing approach means that you will be deducting sales tax from the profit you earn on your products. Many sellers utilize reports generated monthly to determine which sales were subject to tax.
With an exclusive pricing, the tax calculation is conducted at the time of checkout and applied to the purchase. Customers will pay a different final price for the product depending on if sales tax was applied and the specific rate in their state/municipality.
Tools and Automation for Sales Tax
There are tools designed to make collecting and remitting sales tax easier. Automation of sales tax collection is a wise decision for online sellers of digital products.
For example, TaxJar is a software tool that ensures that you are collecting the correct amount of sales tax from customers. It has a comprehensive database of locations and tax rates. You can utilize TaxJar at the time of checkout or upload transaction information regularly to determine your sales tax due.
In addition to ensuring correct calculation of sales tax rate for transactions, many automation tools offer a service that submits your sales tax payments to states as needed. If you sell on multiple marketplaces as well as your own website, having all the information in a single location can help you stay organized.
There are a number of options for sales tax automation including Taxjar, Taxify.co, and Avalara.
Does RD2RD Collect Sales Tax for Vendors?
RD2RD is a marketplace facilitator. In some states, marketplaces are being required to collect and remit sales tax on behalf of sellers. However, for most states, this requirement doesn’t take effect until a specific sales volume (i.e. $250,000 annual sales).
Currently, RD2RD doesn’t meet the threshold to be required to collect and remit sales tax on behalf of vendors. The terms of service describes this in more detail.
What tools does RD2RD have to help me with taxes?
Your vendor dashboard is your one-stop resource to review your sales/earning history and customer details.
In the order history tab of the vendor dashboard, you can review customer details for each sale. This includes customer address information. The location of the purchaser/buyer is essential to determine if sale is subject to sales tax (based on your nexus).
What about sales in other countries, like value added tax (VAT) in Canada and the EU?
RD2RD currently allows sales in Australia, Canada the United States as well as U.S. Virgin Islands. You should review the rules related to sales tax in these countries as well.
Summary
While sales tax probably isn’t the most exciting topic, it is an essential aspect of selling online. Take time to research and review the resources shared to better understand this topic. However, they are not a substitute for a tax professional experienced in sales tax.
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