Charging sales tax based on an IP address

When your customers shop with you online, they provide a physical billing or shipping address. Whether they know it or not, they also give you another bit of location information: an Internet Protocol (IP) address.

Many tech companies consider themselves service providers, exempt from sales and use tax. But in light of the 2018 Wayfair decision and an expanded definition of nexus, more of these businesses are now subject to sales and use tax collection on these services, including but not limited to software delivered electronically, “software as a service” (SaaS), cloud-based solutions, VoIP, streaming media and some gaming apps.

Most technology and software companies don’t need to track the IP address because a customer provides a physical address. But a purchase within an app or gaming system may not require the same information, so the location of a purchase can be harder to pinpoint. In these cases, IP addresses have been used for sales tax in certain situations because they can be mapped to a physical address.

One of the potential problems with using IP addresses is that they can cover an incredibly wide area – a potential problem in a nation with some 13,000 tax jurisdictions.

Are IPs the future?

More states in general have long looked for ways to apply sales and other taxes to digital products, which some jurisdictions classify as tangible personal property and some don’t. Six years ago, Texas issued a private letter ruling that using IP addresses for sales tax purposes is acceptable for identifying the location in the case of an out-of-state tech company.

Recently, Massachusetts, Oregon, Indiana New York and Connecticut were among states joining Maryland in again attempting to tax digital advertising and data in new ways. (Measures similar to these have historically failed in state legislatures, though many states do already levy sales tax on other digital products).

Though these bills generally don’t mention IP addresses, how else can companies “pinpoint” sales of an increasing number of digital products for which physical billing/shipping addresses may be inaccurate for sales tax purposes?

But the same holds true for customers’ IP addresses. “Identification of who and where the seller and users are can be difficult or impossible to determine,” reads The New Jersey Division of Taxation report “Studying the Impact of Digital Economy,” billed as a starting point for that state to consider taxation challenges of a digital economy. “A variety of approaches may be needed to understand where a customer is located or assumptions must be made when a source cannot be identified.”

In comments in 2021 to the Maryland Comptroller regarding that state’s regulation of a digital advertising tax, the Tax Foundation noted that IP was among methods uncertain “to actually place a device in or out of Maryland” since a virtual private network (VPN) in a given state could have users anywhere connecting to its servers.

“Will all social media networks now be required to obtain full addresses of their account holders?” the Foundation asked that same year in its piece, “States Consider Digital Taxes Amidst Conflicting Rationales.” “Or would it be based on IP addresses, which are already imperfect, but would also be complicated by travel or by people splitting time across multiple addresses? If someone regularly checks a social media account at their home in one state and their office in another, is the tax owed in both?”

‘Guess’

“You can often make a general guess at the physical location corresponding to an IP address, but you usually can’t find an IP address location down to the exact building without information from the service provider that issued the IP,” according to the tech news site Tech Walla. “This information usually isn’t available without a court order or without going through other legal processes.”

How useful is that in some states, where sales tax can vary by city, town – even by neighborhood?

“We don’t recommend you use only an IP address to determine how much tax to collect,” says Stripe, the payment processor, “because the location associated with an IP address might be at a distance away from the actual location where your customer is using it.”

Tech companies may not have to think about IP addresses and sales tax obligations yet. But when the day arrives, how will nexus be accurately determined, and how will taxes be assessed? Stay tuned.

Sales tax laws and regulations can change now faster than ever. We can help you comply and stay on top of this critical question. Contact us to learn about the latest developments in sales-tax nexus and what they mean to you and your company.