Are You Paying the iTunes Tax?

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If you live in one of the nearly 25 states that charge sales tax on digital goods or services you likely pay more for everything from downloaded music, e-books and ringtones to streaming TV shows and video.

And a growing number of states are finding ways to tax our digital diversions. While some states rely on existing sales tax laws, more than a dozen have enacted sales tax laws specifically targeting digital goods.

In July, Minnesota's residents will be the latest consumers to pay tax on digital products, under a provision of the state's tax bill passed in May.

As consumers switch to digital music, books and movies, many states discovered that they were losing out on valuable sales tax revenue and decided to do something about it, said Michael Mazerov, a senior fellow at the Center on Budget and Policy Priorities, a nonprofit think tank.

E-book sales, for example, rose 44% to $3.04 billion in 2012, according to the Association of American Publishers and the Book Industry Study Group. Meanwhile, digital music sales, were up 9.1%, with digital transactions making up a record 37% of all album purchases, according to Nielsen.

What exactly is taxed varies widely by state. Washington state, for example, taxes digital content regardless of how it is delivered; while other states tax music and videos that are downloaded, but not when streamed through a service like Netflix or Spotify.

Here's what some residents currently pay:
  • iTunes: Downloaded music is one of the most commonly taxed digital goods. For example, a $12.99 album downloaded from iTunes (AAPL) carries a state sales tax of 52 cents in Wyoming, 78 cents in Vermont and 91 cents in Mississippi.
  • E-books: States that tax iTunes also tax downloaded e-books. Take New Jersey, which levies a 70-cent tax on a $9.99 purchase, or Utah which imposes a tax of 47 cents.
  • Mobile phone apps: Apps are a unique case. Some states that don't tax "digital goods" still tax apps, the same way they tax software downloaded to a computer. For example in New York, a $2.99 Angry Birds download from the iTunes store will carry a 12-cent tax. But if a New Yorker downloads music or a movie from iTunes they won't get taxed because the state doesn't tax digital goods.
  • Netflix streaming video: Taxes on streaming content are less common. Washington state, for instance, levies 52 cents in sales tax on a $7.99 monthly Netflix (NFLX) streaming subscription. Florida meanwhile, which does not have a sales tax on digital goods, imposes a roughly 54-cent state tax on the same Netflix subscription under its communications services tax.

The rush among the states to tax digital content comes as federal lawmakers consider the "Marketplace Fairness Act," which would allow the 45 states (and the District of Columbia) that currently charge sales tax to require online retailers to collect taxes on purchases made by their residents.

Currently, online sellers are only required to collect taxes in states where they have a physical presence, such as a store or a warehouse. Under the proposed law, online sellers that have sales of at least $1 million outside of states where they have physical operations could also be required to collect sales tax.

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The legislation wouldn't create any new taxes on digital goods, but it would let states enforce the laws that are already in place.

Most states tax a purchaser based on where their billing address is located, but there are no firm national guidelines, said Stephen Kranz, a partner at Washington D.C.-based law firm McDermott Will & Emery who specializes in tax policy.

Tax critics, like Americans for Tax Reform, are concerned that different states will try to tax the same digital purchase. So a resident of Washington state that buys digital music while traveling in Utah could end up paying sales tax twice.

The Download Fairness Coalition, which includes tax reform groups and members of the digital industry, are pushing for additional legislation that would create national guidelines and prohibit that from happening.

Critics also argue that digital goods shouldn't be taxed the same way as physical goods since users are often paying only for a license, not "tangible physical property."

"You can gift your records in your will," said Katie McAuliffe, executive director for digital liberty at Americans for Tax Reform. "You can't do that with your iTunes library."

To find out what items are taxed in your state and at what rate, contact your state's tax and revenue agency. A map with links to the 50 state tax websites can be found here.

More from CNNMoney:

Most outrageous tax cheats
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Are You Paying the iTunes Tax?

To reduce his tax liability, Michael Chen, the owner of Fune Ya Japanese Restaurant in San Francisco, hid cash transaction records in 26 boxes labeled "Seasoned Octopus" in a crawl space under his restaurant and pretended they were never made, according to the IRS.

While he had an encrypted spreadsheet showing total sales of nearly $2 million between 2004 and 2006, he only reported sales of a little over $500,000 on his tax returns. Chen was sentenced to almost three years in prison in January, and he must pay restitution of $459,105.

Lori Wiley-Drones and Edward Drones, of Anchorage, Alaska, adopted a child who had a trust fund of more than $830,000. The child, who was abused by previous foster parents, was granted the trust as the result of a lawsuit claiming the state of Alaska failed to protect him.

The Drones were required to keep the trust completely separate from their own accounts, but they couldn't resist dipping into the money. They allegedly used it to remodel their home, pay credit card bills, buy cars and even splurge on Coach purses and jewelry -- leaving only $15.05 in the child's trust fund.

They also neglected to report the the funds as income on their tax returns, according to the IRS. But they were finally caught, and in March the couple was sentenced to nearly four years in prison and required to pay restitution of $829,417.

Archie Cabello, from Portland, Ore., used his job as an armored truck driver to cash in on a huge pile of cash that he was supposed to protect. Cabello was transporting $7 million for Oregon Armored Services.

To carry out the scheme, his brother took two bricks of hundred dollar bills totaling $3 million from the back of the truck and drove it to a safe deposit box, while Cabello handcuffed himself to the truck door to make it look like he had been robbed and told a passerby to call the police, according to the IRS.

Cabello allegedly spent $1 million by the time he was caught. The IRS nabbed him for failing to report the stolen funds on his taxes. Even if money is received illegally, it's still considered income so you're required to report it to the IRS. He pleaded guilty to a number of charges, including conspiracy to commit bank larceny, money laundering and filing a fraudulent tax return, and he was sentenced to 20 years in jail.

To get out of paying $220,000 in taxes, James Stuart, from Hartland, Wisc., failed to report $900,000 in income between 2005 to 2007 -- allegedly telling the IRS he didn't have a social security number, he wasn't an American citizen and the IRS didn't have the right to tax him.

But perhaps his most bizarre claim of all was that he had "loaned his consciousness to a trust entity" and therefore couldn't pay taxes, according to the IRS. Stuart was sentenced to nearly three years in prison and fined $6,000.

Monty Ervin, from Montgomery, Ala., allegedly neglected to report more than $9 million in rental income from his property management company and failed to pay $1 million in income tax. To justify the tax evasion, Ervin attempted to renounce his U.S. citizenship multiple times, saying he was a "sovereign citizen" and not subject to the law.

He even allegedly claimed that he was the governor of Alabama in its "original jurisdiction," and the government found that he had buried $350,000 worth of gold coins in his yard. When he was arrested this March, the Justice Department said he was carrying a notebook with coordinates for an island off the coast of Honduras.

Ervin was sentenced to 10 years in prison and is required to pay $1.4 million in restitution to the IRS.


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