States seek levies on digital-media downloads

By Declan McCullagh and Anne Broache
Staff Writers, CNET News.com
April 13, 2006 4:00 AM PDT

Internet shoppers accustomed to tax-free purchases from Apple Computer's iTunes Music Store soon may be in for an unpleasant surprise.

State legislatures and tax officials, eager to find new ways to boost government spending and curb budget shortfalls, are eyeing the burgeoning market for digital downloads as a potentially lucrative source of revenue.

A CNET News.com analysis shows that 15 states and the District of Columbia now tax downloads of music, movies and electronic books. Some high-tax states such as California do not levy the same charge on iTunes downloads, but that could soon change.

"More states are beginning to tax downloaded products," said Steve Krantz of the Council on State Taxation, which represents companies that do business in many states. "Some are doing it through specific legislation. Others are doing it through the interpretation of previous law."

Does my state tax digital downloads?

While most states still only tax "tangible" online purchases, others are making exceptions for digital downloads, according to CNET News.com research.

Click a state above to learn more about that state.

Alabama

State statute/proposal

Alaska

Alaska has no sales tax

Arizona

Arkansas

California

"Sales tax applies to tangible personal property--things you can hold, touch, feel, see--and downloaded music is not considered to be tangible personal property."

- Anita Gore, spokeswoman, State Board of Equalization

State statute/proposal (pdf)

Colorado

Connecticut

Delaware

Delaware has no sales tax

Florida

"Sales tax is not due because sales tax generally applies to the sale of tangible things, and when music or other content is downloaded, nothing tangible is generally received. Thus, no sales tax is due. However, note that if the same content were sold on a disc or in some other tangible form, it would be subject to sales tax, as there would now be tangible personal property that the tax would apply to."

- Renee Watters, chief of public information, Department of Revenue

State statute/proposal

Georgia

"We don't impose sales and use tax on digital goods."

- Charles Willey, spokesman, Department of Revenue

State statute/proposal

Hawaii

Idaho

State statute/proposal (pdf)

Illinois

"If you download Microsoft Word, it's taxable...if you download "Walk the Line" by Johnny Cash, we don't consider that software (or taxable)."

- Mike Klemens, spokesman, Illinois Department of Revenue

State statute/proposal

Indiana

"Digital goods purchased via the Internet are treated the same as software purchases, and therefore, they are subject to sales tax."

- Stephanie McFarland, spokeswoman, Indiana Department of Revenue

State statute/proposal (pdf)

Iowa

Kansas

Kentucky

"We tax digital downloads of computer software and music as tangible personal property."

- Jill Midkiff, spokeswoman, Kentucky Department of Revenue

State statute/proposal (pdf)

Louisiana

State statute/proposal (pdf)

Maine

State statute/proposal

Maryland

State statute/proposal

Massachusetts

"We do not tax downloads of digital goods; we consider it information, and we don't tax information."

- Tim Connelly, spokesman, Massachusetts Department of Revenue

State statute/proposal

Michigan

"We do not have a sales tax on an actual digital download. If you were to, say, purchase something that was prewritten computer software that was, in essence, delivered electronically, then we would, but not on something from, say, iTunes."

- Caleb Buhs, spokesman, Department of Treasury

State statute/proposal

Minnesota

Mississippi

State statute/proposal

Missouri

State statute/proposal

Montana

Montana has no sales tax

Nebraska

Nevada

New Hampshire

New Hampshire has no sales tax

New Jersey

"(Digital downloads) are not (taxed) at the moment, but there is a pending proposal."

- Tom Vincz, spokesman, New Jersey Department of Treasury

State statute/proposal (pdf)

New Mexico

New York

"(Downloads of) music, movies, pictures, graphic files, that type of stuff is not taxable."

- Michael Bucci, spokesman, New York State Department of Taxation and Finance

State statute/proposal

North Carolina

"There is no tax like that (on digital downloads) here?I can't say there won't be on in the future, but for now, there is not one."

- Kimberley Brooks, spokeswoman, North Carolina Department of Revenue

State statute/proposal (pdf)

North Dakota

State statute/proposal (pdf)

Ohio

"We do not (tax downloads of music, etc.). Software, we do tax, if it's electronic transfers of prewritten computer software."

- Gary Gudmundson, spokesman, Ohio Department of Treasury

State statute/proposal

Oklahoma

Oregon

Oregon has no sales tax

Pennsylvania

"If you buy music on a CD, the CD is tangible personal property; it's subject to tax. If you download it, our interpretation was it's not taxable because it's not tangible."

- Steve Kniley, spokesman, Pennsylvania Department of Revenue

State statute/proposal

Rhode Island

State statute/proposal

South Carolina

"Unlike computer software delivered in the form of a computer diskette or magnetic tape, computer software sold and delivered by electronic means cannot be seen, weighed, measured, felt, touched or is not otherwise perceptible to the senses."

- Ruling, South Carolina Department of Revenue

State statute/proposal

South Dakota

Tennessee

Texas

"Except as otherwise provided by this chapter, the sale or use of a taxable item in electronic form instead of on physical media does not alter the item's tax status."

- Texas tax code

State statute/proposal

Utah

"The sale, rental or lease of prewritten computer software constitutes a sale of tangible personal property and is subject to the sales or use tax, regardless of the form in which the software is purchased or transferred."

- Utah state code

State statute/proposal

Vermont

State statute/proposal

Virginia

"(Digital downloading) is not a taxable transaction and has never specifically come up as proposed legislation to tax digital downloads."

- Joel Davison, spokesman, Virginia Department of Taxation

State statute/proposal

Washington

"We have to determine whether the seller has nexus in Washington, but if we get by that point, then sales of song files, and prewritten software files, are subject to sales tax here."

- Gary Davis, tax information and education manager, Washington State Department of Revenue

State statute/proposal

West Virginia

State statute/proposal (doc)

Wisconsin

State statute/proposal

Wyoming

State statute/proposal

Washington, D.C.

This means that more Americans will be obligated to pay more every April 15 because of a concept known as the use tax. If your home state taxes digital downloads, those levies are generally collected either when purchases are made or on tax day, depending on the location of the Internet retailer.

One reason that music and movie downloads have largely escaped the notice of tax collectors is that, until recently, the market was relatively small. But the dizzying success of iTunes and such rivals as Yahoo Music Unlimited and eMusic.com has exposed a rich vein of untapped revenue. Hollywood studios raised the stakes even higher this month by announcing plans to sell movies over the Internet that buyers can keep.

Digital sales of music tripled from 2004 to 2005, leaping from $400 million to $1.1 billion worldwide, according to the International Federation of the Phonographic Industry, a trade association known as IFPI. The U.S. recording industry estimates that domestic sales totaled $503 million last year, but that figure doesn't include movies, e-books, online video games and other forms of digital media.

That remarkable growth has prompted states like Kentucky to revisit their laws and impose new taxes on media downloads. "Music is included because music downloads fit the definition of personal property," said Jill Midkiff, a spokeswoman for the Kentucky Department of Revenue.

"(Taxing downloads is) antiproductive and anticonsumer, and hurts the business. This would be a huge blow against iTunes and the studios that are finally realizing they have to sell their movies online."

--Llewellyn Rockwell Jr., president
Ludwig von Mises Institute

Similar proposals are on the horizon, with Internet companies tracking tax expansion efforts in New Jersey, Vermont and Rhode Island. New Jersey Gov. Jon Corzine, a Democrat, proposed in his budget (click here for PDF) that "downloaded music and videos" be taxed starting Oct. 1. The state tax agency expects legislation to be introduced in June.

Of the 15 most populous states that, together, represent more than half of the U.S. population, three--Texas, Indiana and Washington state--tax media downloads, according to a News.com survey. In addition to the nation's capital, the lesser-populated states that impose such taxes are Alabama, Arizona, Colorado, Hawaii, Idaho, Kentucky, Louisiana, Maine, New Mexico, South Dakota, Utah and West Virginia, according to an industry lawyer.

These states typically say taxing digital-media downloads is a matter of treating physical shopping and online purchases the same. Buying a CD at Tower Records is taxed, the argument goes, so why should a stream of bits from iTunes or Walmart.com be tax-free?

Taxpayer advocates don't accept that premise, saying it represents an unfair addition of tax laws. "It's antiproductive and anticonsumer, and hurts the business," said Llewellyn Rockwell Jr., founder and president of the Ludwig von Mises Institute, a free-market think tank in Auburn, Ala. "This would be a huge blow against iTunes and the studios that are finally realizing they have to sell their movies online."

Music defined as software
Tax collectors in some states where the law does not explicitly permit taxes for downloaded media have invented ways to expand the tax base, anyway.

"Should administrators (interpret tax laws) in the dark? If changes are made in the legislature, we can duke it out as a tax increase."

--Steve DelBianco, executive director
NetChoice

In Kentucky and Washington, state law does allow the taxation of computer software. Washington law defines software as "a set of coded instructions designed to cause a computer...to perform a task," which tax officials have interpreted to include music, movies and e-books.

"We use that same rationale on other types of files, such as music files or video files," said Gary Davis, the state's tax information and education manager. "We view them as similar because they cause some action by a piece of hardware to play them."

Davis recited aloud the definition of computer software from Washington's tax law and said he believed that data files, like an executable program, cause a computer to "perform a task." He said, "I think it's our policy that that's exactly what a music file does in order to hear it."

That definitional elasticity has alarmed online retailers, which say states are interpreting tax laws in ways never envisioned by elected officials or the general public. They would rather see the issue decided openly in state legislatures than behind closed doors by tax agencies.

"Should administrators do it in the dark? If changes are made in the legislature, we can duke it out as a tax increase," said Steve DelBianco, executive director of the NetChoice coalition, which counts eBay, Oracle, Orbitz, VeriSign and Yahoo as members. "The legislatures have to do it in the daylight."

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