States may tax iTunes, other digital downloads

If you enjoy buying music from iTunes, movies from Amazon.com's Unbox, or computer software from anywhere, be warned: the halcyon days of tax-free digital purchases may be over.

With retail e-commerce sales now estimated to exceed $130 billion a year, and iTunes song purchases topping 5 billion, state politicians and tax collectors have begun to levy new fees on digital downloads

The push stems from an odd legal quirk: because most states' tax laws were written long before the Internet existed, they may accidentally immunize downloads from taxation. This is the case even in otherwise high-tax states like California, where physical CDs are taxed heavily but iTunes downloads remain tax-free for now.

Tech industry groups like NetChoice, which counts eBay, AOL, and Yahoo as members, have been lobbying against the rise in so-called iTaxes--with limited success.

Including Nebraska and Tennessee, there are 17 states, plus the District of Columbia, that tax digital downloads, according to our earlier research: Alabama, Arizona, Colorado, Hawaii, Idaho, Indiana, Kentucky, Louisiana, Maine, New Jersey, New Mexico, South Dakota, Texas, Utah, and Washington. (For more details, see our special report from 2006.)

The new Tennessee law (PDF) that taxes "the retail sale, lease, licensing, or use of specified digital products transferred to or accessed by subscribers or consumers" takes effect in January 2009. The Nebraska law, which taxes "sales of digital audio works (music), digital audiovisual works (movies, music videos, TV shows), and digital books," takes effect in October.

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