How Subscription Tax Affects Your Business

The term “subscription tax” does not refer to a separate, distinct tax category. Instead, it describes the application of existing state and local sales tax laws to business models that rely on recurring revenue. These rules are not set at the federal level; each state determines whether and how to tax these transactions. This decentralized approach means that a subscription box delivered to a customer in one state might be fully taxable, while the same product sent to a customer in a neighboring state could be exempt.

Determining the Taxability of Subscriptions

The question of whether a subscription is subject to sales tax begins with the nature of what is being sold. Historically, sales tax has been applied to Tangible Personal Property (TPP), which is any physical item that can be touched and moved. This most directly applies to models like curated boxes that deliver physical goods, such as meal kits or beauty products. In most states, these subscriptions are treated like any other retail sale of goods and are generally taxable.

When a subscription box contains a mix of items with different tax treatments, the rules can be more complex. For example, a wellness box might include a taxable cutting board alongside tax-exempt food items. In such cases, some states require the business to charge sales tax only on the value of the taxable items in the box.

Software-as-a-Service (SaaS)

The tax treatment of Software-as-a-Service (SaaS) is one of the most varied areas of state tax law. Unlike traditional software sold on a physical medium, SaaS is accessed remotely via the cloud, leading to inconsistent classifications. Some states treat SaaS as a taxable digital good, while others define it as a non-taxable service. Certain jurisdictions now explicitly state that prewritten computer software, regardless of the delivery method, is subject to sales tax, meaning a subscription to a project management tool would be taxed.

Streaming Services

Subscriptions for streaming video and audio content also face a patchwork of tax rules, which often depends on how a state defines digital goods. Many states have updated their laws to explicitly include “digital audio-visual works” or “digital audio works” as taxable products, making a monthly subscription to a streaming service subject to sales tax. In other locations, streaming services may remain untaxed because they do not fit the traditional definition of tangible personal property. A state might tax the permanent download of a movie but exempt the temporary access provided by a streaming subscription.

Digital Publications

Digital publications, including e-books and online newspapers, also receive inconsistent tax treatment. Historically, physical newspapers and magazines were often granted tax exemptions, and some states have extended these favorable tax rules to their digital counterparts. However, many other states make no such distinction and tax digital publications as they would any other digital good. This creates a situation where the same content may be taxed or exempt based solely on the subscriber’s address.

The Role of Nexus in Tax Obligations

Simply determining that a subscription product is taxable in a state is not enough to create a collection requirement. A business must also have “nexus,” a legal term for a connection significant enough to justify imposing a tax collection duty. If a business has nexus in a state, it must register to collect and remit sales tax on its taxable sales to customers located there.

Historically, nexus was established almost exclusively through a physical presence, such as an office, warehouse, or employees. For many online subscription businesses, this standard meant they only had to collect sales tax in the state where they were physically located.

The landscape of nexus changed following the 2018 Supreme Court decision in South Dakota v. Wayfair. This ruling affirmed that states could require businesses to collect sales tax even if they had no physical presence. The decision led to the widespread adoption of “economic nexus” laws, which base a tax collection obligation on a company’s level of economic activity within a state.

Under economic nexus, a business establishes a connection with a state once its sales exceed a certain threshold within a year. These thresholds vary, but a common standard is $100,000 in gross sales, while some populous states have higher thresholds, such as $500,000. Many states have also eliminated a separate transaction-count threshold to simplify compliance.

For subscription businesses, the recurring nature of their sales can cause them to meet these economic nexus thresholds quickly. Businesses must continuously monitor their sales activity in every state to identify when they have established nexus and must begin collecting sales tax.

Calculating and Sourcing Subscription Sales Tax

Once a business has nexus and a taxable subscription, it must calculate the correct sales tax. This process is governed by sourcing rules, which determine which jurisdiction’s tax rate to apply. States use one of two sourcing methods: origin-based or destination-based.

In the few states that use origin-based sourcing, the sales tax rate is determined by the seller’s location. This is a simpler method, as the business applies the same tax rate to all taxable sales within that state.

The vast majority of states use destination-based sourcing, where the sales tax rate is based on the buyer’s location. This requires businesses to apply the precise tax rate in effect at each customer’s address. This rate is often a combination of state, county, city, and special district taxes, and can vary significantly within a small area.

Using a ZIP code is often insufficient for these calculations, as a single ZIP code can contain multiple tax districts. An incorrect calculation can lead to under-collecting tax, leaving the business liable for the difference, or over-collecting, which can create legal issues.

Compliance and Remittance for Businesses

After determining nexus and tax calculation rules, businesses must comply with state laws. The first step is to register for a sales tax permit in every state where a nexus obligation exists by submitting an application to the state’s department of revenue.

With a permit, the business must collect the correct sales tax on each subscription payment. For recurring billing, the payment system must dynamically apply the right tax rate for each customer at renewal and stay updated with the thousands of rate changes that occur annually.

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 based on sales volume. Businesses must file a return in each registered state, even for periods with no sales, and remit the tax by the due date to avoid penalties.