How Digital Business Is Changing State Tax Exposure

State tax rules developed around a business world in which geography was easier to see. Companies had offices, employees, property, and customers in identifiable places, making their connections to individual states relatively straightforward. Digital commerce has complicated that picture considerably.

Today, a business can develop meaningful connections across the country through the ordinary course of its operations. The way a website functions, where inventory is stored, how software is delivered and used, and where customers are located can all influence a company’s state tax obligations. As states continue to apply longstanding tax principles to newer ways of doing business, companies may find that assumptions formed years ago no longer reflect their current exposure.

This is where nexus, the connection that allows a state to impose a tax obligation on a business, becomes especially important. Understanding that connection requires an accurate picture of how the company operates today, including changes that may have occurred gradually as the business grew.

Nexus Now Extends Into the Digital Experience

Physical presence remains an important part of the nexus analysis. Employees, property, and inventory located in a state can create filing obligations, including inventory held at a third-party warehouse or fulfillment center. For businesses using multistate distribution networks, it is critical to understand where inventory is stored, who retains ownership, and whether those arrangements create a taxable presence.

Digital commerce adds another layer. Public Law 86-272, enacted in 1959, provides certain protections from state net income tax when a company’s in-state activities are limited to soliciting orders for tangible personal property, with orders approved and fulfilled from outside the state. E-commerce has raised questions about how far that protection extends when a website performs additional functions for customers.

Those questions are now being tested through state guidance and litigation. New York, for example, has taken the position that certain internet activities can fall outside P.L. 86-272’s protection, including some forms of online customer assistance and post-sale activity. The American Catalog Mailers Association case illustrates the broader issue: functionality that may seem routine from a customer-service perspective can become relevant when determining whether a business’s activities remain protected under P.L. 86-272.

For companies that have historically relied on that protection, website functionality deserves periodic review alongside their physical footprint. Changes in how customers interact with the business online can affect the underlying state income tax analysis, even when the company’s offices, employees, and other more visible operations have remained largely the same.

Rethinking Sales Tax for Digital Products

As commerce has moved toward software, cloud computing, and digital services, states have continued to reconsider what falls within their sales tax base. A transaction that was not taxable in a particular state several years ago may deserve another look today, particularly as states develop rules for software as a service (SaaS), digital goods, and other technology-based offerings.

Determining whether a product or service is taxable is only part of the analysis. Businesses also need to determine where the sale is sourced, and digital products can make that surprisingly difficult. With tangible property, the location where a product is delivered generally provides a clear point of reference. Software may be purchased by a company at one address and used by employees working across several states.

Consider a business that sells 500 software licenses to a customer headquartered in Illinois. If those licenses are assigned to users in multiple states, the customer’s billing address may not provide enough information to determine the seller’s sales tax obligations. Depending on the states involved and their sourcing rules, where the users access the software may become relevant. The seller may need information about how those licenses are distributed to determine where tax should be collected.

Sales channels add another consideration. Marketplace facilitator laws generally place sales tax collection and remittance responsibilities on qualifying marketplaces for transactions they facilitate. Businesses that sell through marketplaces versus directly to customers may therefore have different compliance responsibilities across their sales channels. Local sales taxes can add another layer, making it important to understand the jurisdictions in which sales occur and how the applicable rules treat each transaction.

Further Discussion

For a broader discussion of year-end business tax planning, including state and local, federal, and international tax considerations along with finance-function readiness, watch AAFCPAs’ 2026 Business Tax Strategies webinar.

Finding State Tax Exposure Is the First Step

Discovering a potential state tax obligation is the beginning of an analysis, not a conclusion about what a business should do next. The appropriate response depends on the nature and duration of the exposure, the potential tax and penalties involved, and the options available in the states at issue.

In some cases, a business may focus on becoming compliant prospectively. In others, the historical exposure warrants attention, particularly when a state offers a voluntary disclosure program that may provide a path for addressing prior filing obligations. The analysis should consider the potential liability alongside the business’s broader circumstances and plans.

Those plans become particularly important when a business is preparing for a sale, acquisition, outside investment, or other ownership change. State and local tax exposures are routinely examined during tax due diligence, including where a company has established nexus, whether required returns have been filed, and whether sales tax has been collected and remitted appropriately. An issue that has accumulated during years of normal operations can therefore take on greater significance when a buyer or investor begins examining the business.

Reviewing state tax exposure periodically gives businesses more opportunity to understand these issues on their own terms. Changes in where the company sells, stores inventory, delivers digital products, or otherwise conducts business can provide a useful reason to revisit the analysis before a transaction or another major business event brings greater scrutiny.

Putting This Into Practice: SALT

AAFCPAs’ State and Local Tax (SALT) practice helps businesses understand and manage their tax obligations as they expand across jurisdictions and as their operations evolve. Our advisors perform nexus analyses to determine where income, sales and use, and other state and local tax obligations may exist, examining factors such as sales activity, employee locations, property, inventory, and changes in how a business operates. Where potential exposure is identified, we help clients evaluate state-specific requirements and determine an appropriate path forward, including prospective compliance and voluntary disclosure when warranted. We also support multistate filings and sales tax automation, state correspondence and audit matters, and SALT due diligence associated with business sales, acquisitions, outside investment, and other ownership changes. By combining technical tax knowledge with practical guidance and technology, we help businesses manage ongoing compliance, address issues before they become more difficult to resolve, and understand how state tax considerations may affect future growth.

These insights were contributed by Kelly Zack, MST, Partner, State & Local Tax (SALT).

Questions? Reach out to our author directly or your AAFCPAs partner.

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