The rapid evolution of the digital economy has posed significant challenges for state tax authorities in determining how to effectively tax digital products and services. The Multistate Tax Commission (MTC) continues to spearhead efforts to create a framework for states that wish to expand their sales tax base to include digital goods. At the forefront of this initiative is the State Taxation of Digital Products Project, which aims to develop a broad definition of digital products that states can use as a guideline for future tax legislation.

The MTC’s work is critical because the shift from physical to digital commerce has left many states with outdated tax structures that fail to capture modern business activities. Traditionally, states imposed sales taxes on tangible personal property, but as technology has progressed, consumers and businesses alike have shifted toward digital consumption. Whether it’s streaming services, cloud computing, mobile applications, or virtual goods, states must now decide how to integrate these transactions into their tax codes without creating confusion, double taxation, or unnecessary administrative burdens.

As digital commerce continues to expand, state tax authorities face mounting pressure to modernize tax policies that were crafted in a pre-digital era. Some states have opted for aggressive approaches, attempting to capture revenue from digital transactions through broadly written statutes, while others have taken a more cautious approach, recognizing the potential legal and administrative challenges of taxing digital products inconsistently. The implications of this ongoing debate reach far beyond tax administration, affecting consumer pricing, business investment, and compliance burdens for companies operating in multiple states.

This article provides an in-depth overview of the latest developments in the MTC project, the challenges associated with defining and taxing digital goods, the varied approaches different states are taking, and the potential implications for businesses operating across multiple jurisdictions.

The Role of the MTC Project

The Uniformity Committee of the MTC is actively working on a project to establish a comprehensive definition of digital products. While the project itself does not advocate for or against the taxation of digital goods, its primary objective is to provide a model definition that states can use to modernize their tax statutes.

One of the most pressing concerns in the State Taxation of Digital Products Project is how digital transactions should be categorized. Traditionally, tax laws were designed to address physical transactions, where tangible goods were bought and sold within clearly defined state borders. However, digital goods—such as e-books, software, and streaming services—are often intangible and delivered across multiple jurisdictions, making it difficult to assign a specific taxing authority.

The Task Force overseeing this initiative has been closely monitoring developments and analyzing the broader implications of digital taxation. According to the Task Force, its role is not to promote tax expansion but rather to ensure that any changes made to state tax systems are implemented with clarity and consistency. One of the key concerns is addressing unforeseen consequences that could arise from broadening the sales tax base to digital products without a well-structured framework.

State tax authorities recognize that many traditional tax rules are ill-equipped to handle digital transactions. As e-commerce and digital services have become more prominent, the MTC aims to create guidelines that:

• Avoid double taxation or conflicts with existing tax statutes.

• Provide clear definitions that states can adopt without ambiguity.

• Consider business implications for both B2B and B2C digital transactions.

• Ensure compliance with federal laws, including the Internet Tax Freedom Act (ITFA).

Defining Digital Goods: The Key Challenge

One of the most significant hurdles in the project is developing a universally applicable definition of digital products.

At a recent MTC meeting, the commission announced that it would focus on crafting a broad definition of digital products rather than taking an incremental approach by specifying different types of services individually. The alternative approach of listing taxable services one by one would be handled separately by the Streamlined Sales Tax (SST) Project.

A notable contribution to the project comes from Ray Langenberg, who has proposed the following working definition:

“Automated digital product” – an item, including software and service, which is provided for noncommercial use in a binary format, and for which additional human intervention to produce a similar item for additional customers is minimal.

This definition seeks to eliminate distinctions between tangible personal property and digital services while also disregarding the method of delivery (e.g., download, streaming, or cloud-based access).

However, this broad definition raises several questions:

• Scope of Taxation: Would a physical CD purchased from Walmart containing digital software be treated as an “automated digital product”?

• Internet Tax Freedom Act (ITFA) Compliance: The proposal does not incorporate ITFA principles, which could lead to legal challenges in states that attempt to tax digital goods delivered via the internet.

• Compatibility with Existing Tax Codes: States that currently differentiate between digital services and tangible goods may face difficulties integrating such a broad definition.

Ray Langenberg’s model references the United Nations Model Taxation Convention (2021), which classifies digital services into categories such as:

• Online advertising services

• Supply of user data

• Online search engines

• Online intermediation platform services

• Social media platforms

• Digital content services

• Online gaming

• Cloud computing services

• Standardized online teaching services

While these categories provide useful examples, they do not fully address the complexity of distinguishing business-to-business (B2B) transactions from business-to-consumer (B2C) transactions, which could significantly affect tax liabilities. Furthermore, certain digital transactions—such as peer-to-peer services, blockchain-based assets, and decentralized finance applications—are emerging in ways that current tax models may not be equipped to handle.

The Importance of Stakeholder Involvement

A crucial aspect of the MTC’s project is stakeholder engagement. Recognizing that the taxation of digital products will affect a wide range of industries, the MTC has formed a new workgroup to gather insights from both state governments and private-sector representatives. This is a shift from previous working groups, which were composed exclusively of state tax officials. The inclusion of private-sector voices ensures that policymakers understand the practical business implications of their decisions.

Key stakeholders involved in the discussion include:

• Technology firms that develop and distribute digital goods.

• E-commerce platforms that facilitate digital transactions.

• Legal and tax professionals who specialize in multistate taxation.

• Consumer advocacy groups focused on protecting taxpayers from excessive or duplicative taxation.

By involving a diverse set of participants, the MTC aims to strike a balance between state revenue needs and business compliance concerns, ensuring that any new definitions of digital products are both practical and enforceable across different jurisdictions.

Conclusion: The Road Ahead for Digital Taxation

The taxation of digital products remains an evolving issue, with the MTC’s work poised to influence state policies for years to come. While the project is still in its early stages, the outcome of these discussions will have significant consequences for businesses, consumers, and state governments alike.

As states move forward with efforts to update tax codes, businesses must remain proactive in tracking developments, engaging with policymakers, and ensuring compliance with new regulations. The ultimate goal should be a fair and predictable tax system that reflects the realities of the digital economy while maintaining clarity and uniformity in application.

With ongoing discussions, workgroup meetings, and stakeholder feedback, the MTC’s final recommendations will play a crucial role in shaping the future of digital taxation across the United States.