The U.S. Bureau of Economic Analysis places the digital economy as a sizable portion of our country’s GDP at 10 percent with a projected growth of 7.1 percent per year. As this industry has matured, states are increasingly establishing sales taxes on related transactions to capture their share of the revenue. A growing trend is to tax digital advertising services and similar items involving social media with its trove of valuable user data.
These new sales taxes have not been without challenges on a state and federal level, leaving many tax departments and taxpayers with questions about their compliance obligations. Below, we will review the current trajectory of these taxes, discuss their impact on businesses, and other issues to consider for future sales tax requirements.
The Rise of Digital Advertising Sales Taxes After the Wayfair Decision
The Supreme Court’s Wayfair Decision significantly widened the opportunities for states to collect sales taxes from retailers without a physical presence in their geographic border. Online retail businesses were the first affected by new rules imposing collection and reporting obligations on them for sales delivered into a state. Not far behind are the businesses that deal in digital goods and services, including SaaS and other items transferred through the internet.
In 2021, Maryland became the first state to enact a tax on gross receipts from digital advertising with its passage of HB 732 and SB 787. This tax places an obligation on social media and other large internet-based companies that collect revenue from selling advertising space through their online platforms. Maryland’s tax only applies to larger companies with annual gross revenues of $100,000,000, but any company with $1,000,000 in digital advertising revenue in the state must file Form 600.
After its passage, the tax was quickly challenged in court with claims that it violated state and federal law. The Supreme Court of Maryland denied these challenges on jurisdictional grounds in a ruling dated May 9, 2023, effectively keeping the tax in place. However, a federal lawsuit continues to work its way through the court system with The U.S. Court of Appeals for the 4th Circuit recently remanding the case back to the District Court level to consider a first-amendment challenge to the tax.
Which Other States Are Considering Taxes on Digital Advertising and Related Items?
The uncertainty around the legality of Maryland’s digital advertising tax has led to a mixed response from other states in enacting similar taxes. Some states have started circulating bills within their legislatures to tax digital advertising receipts while others are proposing taxes in other aspects of the digital economy such as social media and data mining. For example, the following states have previously introduced legislation to impose a tax on digital advertising similar to Maryland:
- Arkansas
- Connecticut
- Massachusetts
- New York
- Texas
The state of Nebraska also made headlines this year by introducing bills (LB 1310 and LB 1354) in January to enact its own digital advertising tax that would mirror Maryland’s law. However, the legislature did not enact these bills before its session ended after receiving criticism from interested parties and considering the ongoing litigation involving Maryland’s digital ad tax.
Beyond digital advertising revenue, several states are introducing taxes on items related to digital advertising, including social media and sales of personal data. For example, Indiana’s HB 1572 proposed to apply a $5 fee to social media companies for each active account holder in Indiana. The state of Oregon’s legislature has introduced a data mining tax of 5 percent of the gross receipts from selling personal information in the state. While these states have not formally passed these bills yet, their introduction in legislative chambers shows an eagerness to capture revenue from previously untaxed aspects of the digital economy.
Who Is Responsible for Reporting and Collecting Taxes on Goods and Services in the Digital Economy?
The majority of responsibility for reporting and paying digital economy taxes will belong to the companies that participate in this industry. This could include social media platforms, data miners, and other companies with receipts from digital advertising sales or internet-based activities. Time will tell how these compliance obligations will unfold. Some states may lump these taxes with the state’s standard sales and use tax returns while others may adopt unique forms and reporting requirements.
Potential Issues to Consider During an Assessment or Audit Involving Digital Goods and Services
New taxes on the digital economy will surely provide additional challenges for compliance during an audit or assessment. A preliminary issue will be identifying which state’s taxes a company is subject to paying. Under economic nexus thresholds and other standards by state law or regulation, taxpayers will need to develop methods and systems for determining their obligations. For example, identifying the location of social media account holders or viewers of a digital ad through tracking of IP addresses and other data. Companies may want to start developing their frameworks for demonstrating compliance with these new taxes through internal reporting to identify when taxes may apply to them and what that liability could be.
Consult with a Sales Tax Professional Today about Transactions Involving Digital Goods or Services
The state and local tax obligations of internet companies and social media platforms will only continue to grow as tax departments, legislatures, and courts work through the effects of the Wayfair Decision. Staying aware of tax developments in the digital economy is the first step for proactive business owners and executives. If you have any questions about sales taxes involving digital goods and services, please do not hesitate to reach out for consultation. Our team of sales tax professionals provide audit and appeal services to clients facing burdensome assessments and obligations with state tax departments.
Schedule a consultation today.