Federal Digital Goods Act Would Keep States at Bay

By Wayne Rash  |  Posted 2012-04-22

Amazon, Internet Sales Draw Covetous Looks From State Tax Collectors

Imagine for a minute that you're about to buy a Kindle ebook from Amazon. Yes, I know that it's not much of a stretch, since there's a high likelihood that you have actually done this or purchased some other personal electronic product online. Or perhaps you've downloaded some music from iTunes or a movie from Netflix. Chances are, you didn't pay any sales tax on the stuff you bought.

Likewise, imagine you're buying a computer from HP. You'll likely pay a state sales tax to the state where you reside, but you won't pay a sales tax to California where HP is headquartered unless you live in California.

So you know how sales taxes currently work€”you either pay tax on the item where you are when you buy it, or where you live if you have it shipped home, even if you happen to be in, say, Hawaii on vacation when you placed the order for that HP computer.

But now let's suppose that the state of Washington decides it wants to charge sales tax on the Kindle book you just bought from Amazon as does the state where you live. And then let's suppose that another state, perhaps Illinois, wants to charge sales tax because that's where the Amazon server is located that delivered the book to you. Then suppose that Virginia decides to charge a sales tax because the electronic transmission for your book passed through Virginia (about 70 percent of the world's Internet traffic passes through Virginia).

So let's say that each of those states wanted to charge you a 5 percent sales tax on that ebook. For a $10 book that's 50 cents per book, meaning your $10 book just cost $12. This sounds pretty bad, but it is, in fact, being considered by several states. There is a law that's been working its way through Congress that would prohibit this practice: the Digital Goods and Services Tax Fairness Act (H.R.1860), which would make it federal law that you could be taxed only where you live for your purchase on the Internet.

In other words, just because Amazon is located in Washington, that state couldn't also tax the transaction. And right now they don't. But that doesn't mean that the state of Washington doesn't want to. In fact, the state of Washington has been studying ways in which it can do just that. So have several other states.

In one sense it's understandable. States are in a money crunch, and they see a lucrative new source of revenue. So, you may ask yourself, why isn't the state of Washington already taxing those books or kitchen gadgets you buy from Amazon? The reason is that they can't. The U.S. Constitution prohibits it. If you buy something from Amazon, you may owe that tax to the state where you were when you bought the products, but not to Washington.

Federal Digital Goods Act Would Keep States at Bay


You should know, however, that many states may have what's called a "use tax," which is a lot like a sales tax, and usually it's at the same rate. In those states, you're required to report on what you bought outside the state that you didn't pay a sales tax on and pay a tax to your state. And that's where the Constitution comes in. The courts have decided that the Commerce Clause of the Constitution means that you don't have to pay taxes to states where you didn't buy something.

So why should music, video or ebooks be any different? The bottom line is because they're digital. They're not tangible, physical property. Right now, there are a lot of different interpretations of how to tax digital property. If the state of Washington decides that the sale takes place in Washington because that's where you ordered the music from, then they may decide to tax it.

Complicating all of this even more is that legally you don't really buy music any more than you buy movies or ebooks. What you're actually buying is a license to use the music or movie or ebook. The law where the sale of licenses is concerned is, to put it politely, a mess. Many people think licenses are actually a service rather than a product, and if that's the case, then they should be taxed as services.

But most states don't tax services, which is why your doctor doesn't charge you a sales tax when you get your allergies checked. But you do pay a sales tax on the nasal spray when you go to the drug store (at least in most states).

So if licenses are a service, how can states tax those? Some argue that they can tax specific types of services in the place where the service is performed. But is the service performed where the money is taken? Is it performed where you exercise the rights granted by the license when you listen to the music? Nobody really knows the answer to that, but everybody wants a cut of the sales just in case.

To make matters worse, the proposed law is still in committee in the House Judiciary Committee, and has yet to be reported out for a vote. There are a lot of folks who think the law has some problems with unintended consequences. Then there's the effort by 44 states to agree to use the Streamlined Sales Tax system in which merchants who sell over the Internet or by mail order would collect taxes for your state. The Digital Goods law is in conflict with the streamlined sales tax effort.

This lack of clarity in legal authority and interpretation probably doesn't let you off the hook. I've never seen a state fail to charge a tax where it thinks it can get away with it. So be prepared for multiple levels of tax on your online purchases. That is, unless Amazon moves to Bermuda to avoid those taxes altogether. 


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