Accounting
The brave new world of taxing digital bundles
As the range of digital goods and services expands every day, the tax issues associated with them have only grown, and one of the most complicated issues that retailers, providers, and tax authorities are facing currently involves digital bundling.
Since the beginnings of sales taxation, retailers have been tasked with collecting the total tax from customers and remitting it to the proper tax authorities, according to Scott Peterson, vice president of U.S. tax policy and government relations for Avalara — a fairly straightforward proposition.
“Over time, retailers began putting different products together to sell as a bundled item,” Peterson said. “For example, at Christmas, grocers put together gift baskets with fruit, cheese, a knife, cutting board, etc. When that was done in a state that exempts groceries (and most states do so) fruit and cheese are exempt, but other items are subject to sales tax. States and retailers have struggled to come to consensus on what should be charged for bundled items.”
“Predominant use” is the phrase typically used in taxation. The state wants to determine the motivation driving purchases to arrive at a relatively uniform direction to determine taxation.
And then came digital products, and with those products, a greater number of things to be bundled together that are treated quite differently from state to state. This started with the telephone industry, and the companies looked to states and Congress to find a rational way to tax, given that some items on the phone bill were exempt from sales tax. And states were all over the board in terms of how they taxed or exempted what was on the telephone bill.
For example, phone companies used to have warranties to cover phone lines in a user’s house in addition to outside the house. After years of this, telephone companies convinced states to support congressional legislation to allow them to use books and records to prove they remitted the right amount of tax to states, regardless of what was listed on a telephone bill. The telephone companies provide a bill to consumers that shows the portion subject to sales tax — but it’s confusing to consumers, since the companies don’t have to itemize the tax on their bill.
The current landscape
Today, states have rules in place specific to digital goods and services, according to Peterson.
“The Multistate Tax Commission has been studying digital goods to figure out if a definition actually represents what’s being sold,” he said. “The MTC has written a research paper on the digital goods industry, and now they are trying to figure out digital goods bundling — whether it’s a bundle of all digital goods, or digital goods bundled with hardware. “
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“It’s very complicated because businesses are so creative, constantly trying to find ways of selling goods produced,” Peterson explained. “The marketing department often doesn’t care what the tax department thinks when a product is in development. This is easy if you’re selling shoes, but in selling digital goods, it becomes very complex.”
“Marketing is driving complexity on the tax side, as there are so many things that can be sold together,” he noted. “Many states exempt real-time digital classes, such as webinars for CPE, for example. But if you record that class and make it available on demand, it’s no longer live. States then treat it as taxable — it’s no longer education, it’s something else, and states are working to determine how to characterize that ‘something else.'”
The MTC’s primary concern is that this situation will only get worse as everything goes digital.
“The SST [StreamlinedSalesTax] attempted to put together a bundled transaction rule 20 years ago, but it’s now out of date,” said Peterson, who was previously executive director of the SST Governing Board. “MTC is in the discovery phase now of looking at digital goods bundling and taxation. States should be thinking about the complexity that goes with how to charge tax on a portion of a sales price for a bundle with taxable and exempt items. How does a seller prove to an auditor that they charged tax on the one taxable item in a bundle? The safest practice in selling a bundled package is to itemize each item and only charge sales tax on taxable items.”
“Businesses need to be able to break the bundle apart,” said Peterson. “The fruit and cheese board was an easy exercise in tax and invoicing, but bundled digital goods is a brave new world for businesses and tax authorities. CPAs would recommend having an invoice that is crystal-clear — ‘I’m selling you A,B,C and D. A and D are exempt, so no tax was charged.’ Every day, some retailer creates a new product/service bundle, and it has the potential to reset the taxation conversation. There are no simple answer in this area.”
And things are only getting more complicated: Peterson further referenced a private letter ruling in which the South Carolina Department of Revenue stated that a company’s sales and rentals of digital textbooks purchased for and used in institutions of higher learning as part of a prescribed course of study are exempt, regardless of the format. (Private Letter Ruling #24-3, South Carolina Department of Revenue, March 18, 2024.)
This is only the latest in a series of state developments, including a California case, Bekkerman, that ruled last month on how the state should
The House unanimously passed four bipartisan bills Tuesday concerning taxes and the Internal Revenue Service that were all
- H.R. 1152, the Electronic Filing and Payment Fairness Act, sponsored by Rep. Darin LaHood, R-Illinois, Suzan Delbene, D-Washington, Randy Feenstra, R-Iowa, Brad Schneider, D-Illinois, Brian Fitzpatrick, R-Pennsylvania and Jimmy Panetta, D-California. The bill would apply the “mailbox rule” to electronically submitted tax returns and payments to allow the IRS to record payments and documents submitted to the IRS electronically on the day the payments or documents are submitted instead of when they are received or reviewed at a later date. The AICPA believes this would offer clarity and simplification to the payment and document submission process while protecting taxpayers from undue penalties.
- H.R. 998, the Internal Revenue Service Math and Taxpayer Help Act, sponsored by Rep. Randy Feenstra, R-Iowa, and Brad Schneider, D-Illinois, which would require notices describing a mathematical or clerical error to be made in plain language, and require the Treasury to provide additional procedures for requesting an abatement of a math or clerical error adjustment, including by telephone or in person, among other provisions.
- H.R. 517, the Filing Relief for Natural Disasters Act, sponsored by Rep. David Kustoff, R-Tennessee, and Judy Chu, D-California. The process of receiving tax relief from the IRS following a natural disaster typically must follow a federal disaster declaration, which can often come weeks after a state disaster declaration. The bill would provide the IRS with authority to grant tax relief once the governor of a state declares either a disaster or a state of emergency and expand the mandatory federal filing extension under Section 7508(d) of the Tax Code from 60 days to 120 days, providing taxpayers with more time to file tax returns after a disaster.
- H.R. 1491, the Disaster related Extension of Deadlines Act, sponsored by Rep. Gregory Murphy, R-North Carolina, and Jimmy Panetta, D-California, would extend the amount of time disaster victims would have to file for a tax refund or credit (i.e., the lookback period) by the amount of time afforded pursuant to a disaster relief postponement period for taxpayers affected by major disasters. This legislative solution would place taxpayers on equal footing as taxpayers not impacted by major disasters and would afford greater clarity and certainty to taxpayers and tax practitioners regarding this lookback period.
“The AICPA has long supported these proposals and will continue to work to advance comprehensive legislation that enhances IRS operations and improves the taxpayer experience,” said Melanie Lauridsen, vice president of tax policy and advocacy for the AICPA, in a statement Tuesday. “We are pleased to work closely with each of these Representatives on common-sense reforms that will benefit taxpayers, tax practitioners and tax administration and we’re encouraged by their passage in the House. We look forward to continuing to work with Congress to improve the taxpayer experience.”
The bills were also included in a recent Senate
The House also passed two other tax-related bills Tuesday that weren’t endorsed in the recent AICPA letter.
- H.R. 1155, Recovery of Stolen Checks Act, sponsored by Rep. Nicole Malliotakis, R-New York, would require the IRS to create a process for taxpayers to request a replacement via direct deposit for a stolen paper check. If a check is determined to be stolen or lost, and not cashed, a taxpayer will receive a replacement check once the original check is cancelled, but many taxpayers are having their replacement checks stolen as well. Taxpayers who have a check stolen are then unable to request that the replacement check be sent via direct deposit. The bill would require the Treasury to establish processes and procedures under which taxpayers, who are otherwise eligible to receive an amount by paper check in replacement of a lost or stolen paper check, may elect to receive such amount by direct deposit.
- H.R. 997, National Taxpayer Advocate Enhancement Act, sponsored by Rep. Randy Feenstra, R-Iowa, would prevent IRS interference with National Taxpayer Advocate personnel by granting the NTA responsibility for its attorneys. In advocating for taxpayer rights, the National Taxpayer Advocate often requires independent legal advice. But currently, the staff members hired by the National Taxpayer Advocate are accountable to internal IRS counsel, not the Taxpayer Advocate, creating a potential conflict of interest to the detriment of taxpayers. The bill would authorize the National Taxpayer Advocate to hire attorneys who report directly to her, helping establish independence from the IRS.
House Ways and Means Committee Chairman Jason Smith, R-Missouri, applauded the bipartisan House passage of the various bills, which had been unanimously passed by the committee.
“President Trump was elected on the promise of finally making the government work better for working people,” Smith said in a statement Tuesday. “This bipartisan legislation helps fulfill that mandate and makes improvements to tax administration that will make it easier for the American people to file their taxes. Those who are rebuilding after a natural disaster particularly need help filing taxes, which is why this set of bills lightens the load for taxpayers in communities struck by a hurricane, tornado or some other disaster. With Tax Day just a few days away, we must look for common-sense, bipartisan ways to make filing taxes less of a hassle.”
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