As schools revamp education, states study how old tax laws impact new models

COVID-19 is changing the way we do school, like so much else. Thousands of school districts and post-secondary educational institutions in the United States started the 2020–21 school year remotely, offering synchronous or asynchronous online classes only. Other schools and districts are finding creative ways to provide in-person classes or blending in-person and virtual classes. And a variety of continuing education and training, from music classes to professional development, are also teaching outside the traditional box.

Moving learning online has wide-reaching consequences, including one that could be unexpected: Online education and training services are more likely to be subject to sales tax than in-person classes. As more education shifts online, states will need to determine how to apply existing sales tax laws to new models.

For example, a ruling recently issued by the Tennessee Department of Revenue explains that while live, instructor-led online courses aren’t subject to Tennessee sales and use tax, self-paced online classes that provide no live online instruction are taxable. The department considers the student to be “paying for the use of computer software” rather than the instruction.

The ruling was requested by a corporation with no physical presence in Tennessee. It prepares students for new careers via three different online instruction formats:

Format 1: Students must complete a certain number of course hours and take a specified number of structured online classes. Instructors give “live online” presentations and take written and verbal questions from students. The instructor and students are on video chat for the entire session.

Format 2: Students must complete a certain number of course hours over a specified period. As with Format 1, instructors give live online presentations and take written and verbal questions from students. The instructor and students are on video chat for the entire session.

Format 3: Students complete the curriculum within a set time frame, at their own pace. Students may take longer than the suggested amount of time but will be charged additional tuition if they do. There’s no live online instruction, but students must attend weekly one-on-one sessions with a subject matter expert in the field. Students access course modules, which include optional prerecorded video content, through their online accounts. “Most students choose to access the optional video content.”

Students don’t download software or course content to their personal computers for any of the three formats.

Tennessee sales tax applies to retail sales of prewritten computer software, as well as “the retail sale, lease, licensing or use of computer software in this state, including prewritten and custom software.” In 2015, Tennessee specified that “‘use of computer software’ includes the access and use of software that remains in the possession of the dealer who provides the software or in the possession of a third party on behalf of such dealer.”

When the software is accessed from Tennessee, the access is “deemed equivalent to the sale of licensing of the software and electronic delivery of the software for use in the state.” Thus, as of July 1, 2015, the access and use of computer software in Tennessee is subject to sales and use tax “regardless of a customer’s chosen method of use.”

The ruling also notes that when a taxable and nontaxable transaction are bundled together in a single sales price, taxability is determined by the transaction’s true object. For Format 1 and Format 2, described above, the software platform allows students to access live lectures online. Thus, “a student’s use of the platform software … is merely incidental to participating in the live class.”

In the case of Format 3, however, students learn primarily by reading online text and watching videos. The Tennessee Department of Revenue determined that although some of the services provided in Format 3 may be exempt from sales tax, “the true object of the Format 3 courses is access to the online course modules” — a taxable transaction.

Although cooking shows abound and YouTube is full of how-to-cook-this-and-that videos, some aspiring cooks prefer in-person instruction. An entrepreneurial individual in New York seeks to meet that demand by offering private baking, cooking, and decorating lessons in clients’ homes.

The cooking instructor offers three types of services:

Service 1: Clients hire the cooking instructor to teach them practical cooking skills while making between one and three dishes. The instructor provides customers with physical or electronic copies of recipes and any pertinent information. The customers purchase all ingredients to prepare the dishes.

Service 2: The same as above, except the cooking instructor supplies some or all ingredients.

Service 3: Clients hire the cooking instructor to teach them decorating skills. The instructor provides a partially finished product (e.g., cut-out cookies or undecorated gingerbread houses), along with necessary decorating items.

There’s a lump-sum charge for each type of service — charges for ingredients and supplies are included in the price.

According to the New York State Department of Taxation and Finance, the services aren’t subject to sales tax. Although New York sales tax does apply to certain enumerated services in the Empire State, cooking and baking lessons aren’t among them.

Some of the ingredients and supplies provided by the instructor could be taxable. While food and food products sold by food stores are generally exempt from New York sales tax, candy is generally taxable. However, since the instructor charges one lump sum for the services and doesn’t separately state charges for the ingredients and supplies, they’re considered incidental to the sale of a nontaxable service. The instructor should pay sales tax on the purchase of any taxable ingredients and supplies.

Sales tax is highly nuanced; slight differences in a service can affect how that service is taxed. The longer the pandemic continues, the more likely education services offered by schools and post-secondary educational institutions will be tweaked. Some such changes could impact taxability.

Learn more about taxing online classes and sales tax requirements for out-of-state businesses.