Online gaming industry revenues in the U.S. alone are set to surpass USD 92 billion in 2022 and sportsbook betting is expected to set an all-time high revenue exceeding USD 5 billion. This explosive growth of online gaming and sportsbook offerings is attracting attention beyond just players and thrill seekers—state and local governments, regulators and tax authorities are all looking at the sector.
If you are in the gaming industry and wondering what is subject to U.S. sales tax, how the tax will be calculated and who is required to collect the tax, this article will help identify key issues and considerations when working through the sales tax complexities.
Online gaming models can be bifurcated into games of skill or games of chance and which are either monetary or non-monetary.
Games of skill require players to use their physical skills, knowledge of the game and strategies to outsmart their opponents (e.g., chess, fantasy sport leagues, certain e-sport games, etc.). While there may be a component of luck or chance with a skill game, the player has a role in determining the game’s outcome. Conversely, players in a game of chance rely on luck, rather than skill (e.g., dice, roulette, sportsbooks, slot machines, etc.) to win. Certain games of chance, like blackjack, may also require skill, such as an ability to make decisions based on prior play. Where both chance and skill are involved, jurisdictional rules often provide guidance and define the game as one or the other.
Monetary platforms charge users for participation (e.g., pay-to-play casino slot games) or require an investment of money to be eligible to win pooled prizes (e.g., fantasy sports leagues). Others may provide free access to the game but require in-game purchases to enhance the gaming experience.
The 2018 U.S. Supreme Court decision in Murphy v. National Collegiate Athletic Association, which invalidated the Professional and Amateur Sports Protection Act of 1992 (PASPA) that prohibited most states from authorizing and regulating sports betting, allowed states to adopt their own legislation regulating sports gambling. As of November 2022, 36 states and the District of Columbia have legalised retail or online sports betting, and more states are expected to legalise sports betting in 2023.
Users access online sportsbooks generally through a phone or computer application. However, wagers can also be placed through retail sportsbook kiosks at a physical location, such as a casino, bar or gaming hall.
A company may have an obligation to collect and remit sales tax on its U.S. sales if it has nexus with a state that imposes sales tax on its products and services.
For most companies, nexus is created through physical presence, such as having physical property (e.g., office, inventory, retail kiosk) or employees in the state. Following the Supreme Court’s 2018 landmark decision in the Wayfair case, nexus can also be established by eliciting sales that exceed economic thresholds (e.g., USD 100,000 of gross sales or 200 separate transactions within the past or current year). All states that impose sales tax have economic nexus standards.
For companies operating in a regulated industry, such as legalised sports betting or online casinos, nexus can also be created based on state regulation, which may require operation only through an in-state licensed retail operator and agreeing to file and be compliant with all applicable taxes as a prerequisite for obtaining a license or having a server in a state.
Approximately 35 states impose sales tax on electronically delivered software, such as a downloaded app installed on a computer or phone. Approximately half of the U.S. states impose sales tax on software as a service (SaaS) and 12 states impose sales tax on data processing or information access services. Over 30 states impose sales tax on various digital products, including in-game purchases.
The taxation of online sports betting is complex and generally includes the following: a federal excise tax of 25 basis points on the amount of each wager, a state-based tax on gross gaming revenue or modified gross profit, and licensing fees. In addition, technology companies, sportsbook and online gaming operators should determine whether sales tax applies to their products and services. For instance, certain states that impose sales tax on data processing, access to information services, data monitoring, streaming and security services may construe certain functions of the sportsbook offering—depending on the delivery—to be subject to sales tax. If a company combines the sale of taxable and non-taxable products and services into a single fee on customer invoices (i.e., a “bundled” transaction), states may consider such sales of separately identifiable services that are combined with taxable components and sold at a single price as a transaction that is taxable in its entirety. Reviewing contracts and invoicing methodologies, therefore, are important to mitigate bundling risk.
Access to software, data or other services, often combined in a service offering, may be purchased by a casino operator but ultimately used by players. As part of the taxability analysis, when a transaction involves taxable (e.g., software) and non-taxable components (potentially services) that are not separable, it is important to analyse the true object (or the essence of the transaction) to determine if taxable items are merely incidental to the overall transaction, thus not subjecting the entire transaction to sales tax. Certain states (e.g., Texas) have attempted to pass legislation imposing sales tax on consumers placing wagers on sporting events.
The availability of any exemptions must also be considered. Some states (e.g., New Jersey) exempt the sale of software when it is electronically delivered and used exclusively in the customer’s trade or business. Other states (e.g., Iowa and Maryland) may exempt SaaS from sales tax if it is furnished for exclusive use by another commercial enterprise.
Companies should also monitor whether they are purchasing software or services for resale, at which point sales tax should not be paid on the purchase, but charged on the sale to the end consumer, unless it is not taxable or another exemption applies. Similarly, companies should know where purchased software or services are used, as a “bill to” location may impose sales tax on the purchase, while the location of shipment or use may not impose tax on the purchase.
Retail sellers of video games must be cognizant of their delivery model (e.g., free download, pay to download, access online) and in-app purchases that may be subject to sales tax, regardless of whether real or virtual currency is used. Broadcasting streams where users can observe other in-play players in certain states (e.g., Florida or Kentucky) may be considered as a taxable service akin to a movie ticket or a pay-per-view event.
Operators of games that permit players to sell in-game items, i.e., digital products, may meet definition of being a marketplace facilitator and thus be responsible for the collection and remittance of sales tax on such transactions in states where they have nexus. All states that impose sales tax have economic nexus standards for marketplace facilitators.
It is important to timely review a company’s physical presence and volume of sales, characterisation of products, contractual language, method of delivery and invoicing methodology to be compliant with U.S. sales tax laws. In addition, for inbound companies, it is important to consider whether U.S. treaty protection may apply for state income tax purposes, and if the company may be subject to additional state taxes and obligations (e.g., payroll tax withholding, personal property tax, unclaimed property, etc.).