Are Subscriptions Subject to Sales Tax?

The subscription-based economy has created sales tax complexity for businesses. In the United States, there is no national sales tax, so rules are dictated by individual states. A subscription’s taxability depends on the product sold, the customer’s location, and the business’s connection to that state, meaning a streaming movie subscription can be taxed differently than a monthly box of goods.

Determining Taxability by Subscription Type

Subscriptions for Tangible Personal Property

Subscriptions for the regular delivery of physical items are subject to sales tax. This category includes services like meal kits, curated boxes of clothing or cosmetics, and recurring shipments of household goods. These transactions are treated as if a customer purchased the same items individually from a retail store.

Complexity arises from the box’s contents. If a box contains a mix of taxable and non-taxable items, the entire charge may become taxable in some jurisdictions. For example, some states exempt grocery items but tax prepared foods. A subscription box with both raw vegetables and a taxable cutting board could require the business to collect tax on the board or the entire price of the box, depending on the state’s bundling rules.

Subscriptions for Digital Products

The taxation of digital product subscriptions is inconsistent across states. This category includes access to streaming video and audio, digital newspapers, and downloadable products like e-books. Since most sales tax laws were written before digital goods, states have taken varied approaches to applying old rules to new technology.

Some states have passed laws to address the taxability of “specified digital products,” where the digital version of a product is taxed if its tangible counterpart is. Other states have determined that because digital products are intangible, they do not meet the definition of “tangible personal property” and are not subject to sales tax.

Software as a Service (SaaS)

Software as a Service (SaaS) is a distinct category for sales tax. SaaS is a model where customers subscribe to access software over the internet rather than purchasing and installing it on their computers. Access to the product ends when the subscription payments stop.

Some states classify SaaS as the sale of taxable prewritten computer software. Other states classify SaaS as a non-taxable service, especially if no part of the software is downloaded and the user is merely accessing it remotely. The taxability can also depend on the end-user, with some states offering exemptions for business-to-business transactions.

The Role of Sales Tax Nexus

A business must have a connection, known as “nexus,” with a state before it is required to collect and remit sales tax from customers in that state. The concept of nexus has evolved from a standard based on physical presence to one that also includes economic activity.

Physical Presence Nexus

The traditional standard for nexus is physical presence. This can be established by having an office, a warehouse, or employees located within the state. Storing inventory in a state, even in a third-party fulfillment center, also establishes physical presence nexus.

Economic Nexus

The landscape of sales tax nexus was changed by the 2018 Supreme Court decision in South Dakota v. Wayfair. This ruling allows states to require out-of-state sellers to collect sales tax even if they have no physical presence in the state. This concept, known as economic nexus, is triggered when a business meets a certain level of economic activity within a state.

The original threshold adopted by many states was $100,000 in gross sales or 200 separate transactions into the state within a calendar year. However, a growing number of states have eliminated the 200-transaction threshold and now rely solely on a sales revenue threshold, which is typically $100,000. Businesses must monitor the specific nexus rules in every state where they have customers.

State-by-State Taxation Rules

States That Broadly Tax Digital Subscriptions

Many states have updated their laws to tax various digital products and services. States like Pennsylvania and Washington have broad rules that treat SaaS, streaming services, and digital downloads as taxable. Connecticut also broadly taxes these services, but the rate depends on the customer.

A reduced 1% tax rate applies when digital services are sold to a business for its use, while the standard sales tax rate applies to sales to consumers. Texas classifies SaaS as a taxable “data processing service,” but with an exemption where tax is only due on 80% of the sales price.

States with Limited or Specific Taxation

In many states, taxability depends on the subscription’s specific characteristics. A state might tax one type of digital product but exempt another. For example, a state could tax downloadable e-books but exempt streaming movie services, viewing the former as a product and the latter as a service.

In some jurisdictions, SaaS may be taxable only if it involves a downloadable component or is sold to an individual for personal use rather than to a business. These distinctions require companies to understand what they sell, how it is delivered, and who is using it.

States That Generally Do Not Tax Digital Subscriptions

Several states do not tax most digital subscriptions because their statutes exclude intangible goods. States like California and Florida do not tax SaaS because it is considered a service and does not involve the transfer of tangible personal property.

However, exceptions can exist even in these states. If a digital product is delivered on a physical medium like a CD, it becomes taxable. Furthermore, if a non-taxable SaaS subscription is bundled with a taxable item, such as consulting services, the entire transaction could become taxable depending on the state’s rules.

The Compliance and Remittance Process

Once a business has a sales tax obligation, it must register, collect, and remit the tax according to each state’s rules to avoid penalties.

Registering for a Sales Tax Permit

The first step is registering for a sales tax permit in every state where the business has nexus. A business is not legally allowed to collect sales tax from customers until it has been issued a permit. Registration is done online via the state’s department of revenue website and requires providing business details.

Calculating and Collecting Tax

After registering, the business must calculate and collect sales tax on taxable transactions. This requires using the correct tax rate, which can vary by state, county, and city. The correct rate is based on the customer’s location, which for subscriptions is their billing address or where they primarily use the service.

Filing Returns and Remitting Tax

The final step is filing sales tax returns and remitting the collected funds. The filing frequency—monthly, quarterly, or annually—is determined by the state and is often based on the volume of sales tax collected. Most states now require electronic filing, and meeting all deadlines is necessary to avoid penalties.