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States’ Sales Taxes on Software

By: Joseph Bishop-Henchman

Get 45 public finance experts in a room and most will agree that a sales taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. should apply to all final sales but not to business purchases, so each product is taxed once and only once. The 45 states with sales taxA sales tax is levied on retail sales of goods and services and, ideally, should apply to all final consumption with few exemptions. Many governments exempt goods like groceries; base broadening, such as including groceries, could keep rates lower. A sales tax should exempt business-to-business transactions which, when taxed, cause tax pyramiding. es do the opposite, exempting many final sales and taxing many business purchases.

Sales tax treatment of software is the subject of this week’s map. Ideally, all software purchases should be taxable to final users and exempt for business users. Instead, states tax some kinds of software and exempt others, based on whether it is customized or off-the-shelf and whether it is on CD or downloaded, all silly distinctions for tax purposes. States like Hawaii, New Mexico, South Dakota, Tennessee, and Texas are at least consistent in taxing it all. No state exempts it all, although Florida and Maryland come close. As for why Arkansas, Ohio, and South Carolina tax custom software when you buy it on a CD but exempt it when you download it, your guess is as good as ours.

We present state tax treatment of five different kinds of software: (1: triangle) pre-made “canned” software purchased in the form of tangible property like a disk or CD; (2: square) canned software downloaded directly onto a computer; (3: circle) custom software purchased on a disk or CD; (4: starburst) custom software downloaded; and (5: star) custom software customized by the user for their use.

All maps and other graphics may be published and reposted with credit to the Tax Foundation.

(Click on the map to enlarge it. View previous maps here.)

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