Sales Tax on Online Classes: A Troubling Trend or Merely a By-Product of the eCommerce Age

By: Michael Colavito, SALT Director

At a glance

• The main takeaway: Rhode Island and Tennessee are among states that impose sales and use tax to digital products and remote access software, and that has led to taxation of online educational courses accessed by students via the Internet.
• Assess the impact: As states continue to broaden the scope of their sales tax base to include electronically delivered or accessed products and services, those rules may result in unintentionally subjecting online educational classes or other similar services to sales tax.
• Take the next step: Aprio’s State and Local Tax (SALT) team can advise you on a wide variety of sales and use tax matters and assist your business to ensure it complies with its sales tax obligations.

Schedule a free consultation today to learn more!

The full story:

In the last few years, several states have addressed the sales tax treatment of online classes. Most recently, on September 5, 2023, the Rhode Island Division of Taxation issued Declaratory Ruling No. 2023-02, where the Division concluded that the taxpayer’s sales of online educational courses accessed by students via the internet are subject to sales tax. The online courses at issue normally consisted of videos, interactive activities and games, animation, and individualized feedback. Only a couple of weeks prior to the Rhode Island ruling being issued, Tennessee issued Letter Ruling 23-07. Tennessee reached a similar ruling in that the fees paid by customers to access the courses, which were largely self-paced, pre-recorded lectures, were subject to Tennessee sales tax. The conclusions in both the Rhode Island and Tennessee rulings were based on the online courses being treated by the states as taxable computer software.

A closer look at the issue:

The potential taxation of online classes, which might initially seem like a nontaxable service, is in large part due to certain types of online courses meeting a state’s definition a taxable digital product or computer software. Well over half the states that impose a sales and use tax now tax digital products to some extent, while roughly 20 states impose sales tax on remotely accessed software (i.e., Software-as-a-Service or SaaS).

Over the last 10 years, states have been playing catchup to maintain sales tax revenue, as consumers have shifted from purchasing items in tangible form to buying digital versions of the same products. Everyday examples of this include purchases of digital versions of movies, books and music. However, when sales tax is imposed on an online class, it’s hard to see an equivalent tangible form of that class that was once subject to sales tax. Still, based on most state’s definitions of a digital product and/or software, it may be difficult to reach the conclusion that online classes delivered in certain formats do not fall squarely within those definitions. 

Thus, the broader issue may be whether from a policy perspective legislators should reconsider treating a consumer’s purchase of a digital movie, book, or music the same as a consumer’s purchase of a course required to maintain their license in a profession or to gain skills required for a prospective profession. Some states have implemented exemptions from sales tax for certain online courses where such courses might otherwise fall within the definition of a taxable sale. Still, these exemptions are often dependent on the format of delivery or level of interaction that the student has with the instructor.

For example, in a 2021 Wisconsin Ruling, the Wisconsin Department of Revenue determined that access to certain courses offered by an online virtual learning platform were not subject to sales tax under the state’s digital goods rules because such items are not taxable if they are transferred incidentally with an educational service. However, this conclusion was limited to the platform’s learning plans that included evaluation by an instructor and/or access to a tutor.

Similarly, Maryland, which also imposes sales tax on certain online classes under its digital products rules, enacted exemptions from its sales tax for charges for:

• Viewing any course or lecture online by an elementary, middle school, high school, college, or graduate school; and
• Online continuing education courses (i.e., courses in someone’s current or prospective occupation) so long as the classes are live and feature an interactive element between the buyer and the instructor (e.g., a live chat function).

The limited nature of the exemption means that a charge for a continuing education course that is a pre-recorded course or a course that consists of on-demand modules may be subject to Maryland sales tax.

Breaking down the issue

Sellers of online courses need to analyze their online course offerings very carefully to reach the correct taxability determinations. Without diving too much into the details, below is a list of issues that should be considered when determining if a state’s sales tax is imposed on the certain online courses.

1. Does the state impose sales tax on digital products?
2. Does the state impose sales tax on SaaS solutions?
3. If the state does impose sales tax on either digital products or SaaS solutions, can the courses at issue, despite being offered via the internet, not be treated as either because the “true object” of the transaction is the purchase of a nontaxable education service?  For example, does live access to an instructor or personalized evaluation from an instructor change the characterization of the sale to a nontaxable education service?
4. Has the state enacted an exemption for educational services? If so, do the courses at issue meet the requirements of the exemption?
5. How does the format of the course impact the taxability? Factors that may be relevant with respect to the delivery format include whether the class is a live presentation, a pre-recorded presentation, or a module-based training, and whether there is contemporaneous interaction with an instructor.
6. Does the sales price to access online courses include other products and services sold by the seller, and does the state have “bundled transaction” rules that dictate the taxability of the bundled price? This issue may arise if the price to the course also includes a textbook or other publications that the attendees are permitted to keep, and whether those are provided in tangible or digital form.
7. How does a single price to access a library of courses (e.g., an annual subscription), only some of which are subject to tax, impact the sales tax treatment? Depending on the state, it’s possible that the taxable courses will taint the entire sale and result in the total subscription price being subject to sales tax.
8. Do these taxes violate the Internet Tax Freedom Act,¹ which prohibits discrimination against electronic commerce?

The bottom line

States will undoubtedly continue to broaden the scope of their sales tax base to include an increasing number of electronically delivered or accessed products and services. Whether or not states specifically intended on imposing sales tax on certain online educational courses when enacting new laws, a state’s imposition of sales tax on digital products or software and the specific definitions included in those rules can easily result in many online classes being subject to sales tax.

Aprio’s SALT team has experience advising clients on a wide range of sales and use tax matters, and we can assist your business to ensure that it complies with its sales tax obligations. We constantly monitor these and other important state tax topics, and we will include any significant developments in future issues of the Aprio SALT Newsletter.

This article was featured in the October 2023 SALT newsletter.

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¹ See 47 USC § 151, notes.