Maryland fine-tunes tax on digital products

Though some states seem to take a “set-it-and-forget-it” approach to sales tax, most states fiddle with their sales tax laws in response to changing circumstances. Maryland offers a good example: It’s been fine-tuning how sales and use tax applies to digital products and digital codes since before tax rules for those items took effect.

Maryland lawmakers broadened sales tax to specified digital products and digital advertising in March 2020 with the enactment of House Bills 732 and 932. It took time for the measures to take effect because Governor Larry Hogan vetoed the bills, but the Maryland General Assembly overrode the veto in February 2021, and Maryland began taxing certain digital products on March 14, 2021.

Shortly thereafter, in April 2021, the General Assembly passed another law amending and clarifying how Maryland sales tax applies to digital products and services. It took effect retroactively, on March 14, 2021.

The General Assembly further refined the state’s tax on digital products in 2022 with the enactment of Senate Bill 723 and its companion House Bill 791. According to the Maryland Comptroller’s Business Tax Tip #29, the exclusions established by the new law reflect “the legislative intent of HB 923 as enacted on March 14, 2021.”

The latest changes took effect July 1, 2022. For the sake of all affected businesses, let’s hope the third time’s the charm and no additional clarifications are needed.

SB 723 excludes the following products from the list of taxable digital products as of July 1, 2022:

• A product having electrical, digital, magnetic, wireless, optical, electromagnetic, or similar capabilities where the purchaser holds a copyright or other intellectual property interest in the product, in whole or in part, if the purchaser uses the product solely for commercial purposes, including advertising or other marketing activities
• Computer software or software as a service purchased or licensed solely for commercial purposes in an enterprise computer system, including operating programs or application software for the exclusive use of the enterprise software system, that is housed or maintained by the purchaser or on a cloud server, whether hosted by the purchaser, the software vendor, or a third party

According to Tax Tip #29, “Although the statutory exclusion is effective July 1, 2022, the legislative history of HB 791 and SB 723 indicates that the software exempted by the bill was never intended to be included in the definition of a digital product as enacted in H.B. 932.” Whether that will affect enforcement remains to be seen.

The following digital products are exempt from Maryland sales tax as of March 14, 2021:

• Prerecorded or live instruction by a public, private, or parochial elementary or secondary school or a public or private institution of higher education
• Instruction in a skill or profession in a buyer’s current or prospective business, occupation, or trade if the instruction:
  • Is not prerecorded; and
  • Features an interactive element between the buyer and the instructor or other buyers contemporaneous with the instruction
• A seminar, discussion, or similar event hosted by a nonprofit organization or business association, if the seminar, discussion, or event:
  • Is not prerecorded; and
  • Features an interactive element between the buyer and host or other buyers contemporaneous with the seminar, discussion, or event
• A professional service obtained electronically or delivered through the use of technology having electrical, digital, magnetic, wireless, optical, electromagnetic, or similar capabilities

The Maryland Comptroller has also determined the following products and services are not taxable, whether sold for business or personal use:

• Cloud storage services and data transfer fees
• Search engine optimization (SEO) services
• Videoconferencing software platforms
• Web hosting services

Custom software is generally exempt from Maryland sales and use tax. If the customization is to be done by the buyer or a third party on behalf of the buyer, the buyer must let the seller know the software will be customized. If a buyer fails to notify the seller that the software will be customized, the seller must charge the buyer sales tax.

Maryland sales and use tax applies to the sale or use of digital products and digital codes as of March 14, 2021. These include but aren’t limited to:

• Apps
  
• Artwork
• Canned software and software as a service (SaaS)
• Digital codes
• Interactive communication and entertainment (including sales made in the metaverse)
• Entertainment (e.g., movies, sporting events, music, audiobooks)
• Prerecorded, noninteractive instruction
• Reading materials (e.g., ebooks or digital magazines)
• Subscriptions

Sales and use tax generally applies whether the buyer has rights of permanent use, rights of less than permanent use, or rights of use conditioned on continued payment by the subscriber or buyer.

The comptroller provides numerous examples of what is and isn’t taxable in Business Tax Tips #29, last updated July 1, 2022.

See our state-by-state guide to the taxability of digital products for more state-specific details. If any other states decide to tax sales of digital products or digital codes, we’ll spread the word at the Avalara Tax Desk.