The popularity of electronic sports continues to grow with increased prize money, larger events, profitable sponsorships, and sports betting. Esports is a multimedia, billion-dollar, global industry where professional gamers compete in tournaments. These gamers have transformed video game competitions into spectator events drawing in millions of fans worldwide. In 2021, more than $240 million in prize money was awarded. Many pro players earn a substantial portion of revenue from the sale of merchandise.

In esports, the term merch, or emerch, refers to branded clothing, accessories, plush toys, sculpture, and digital game art. Emerch is generating a genuine increase in income, bringing with it the task of tracking state tax nexus thresholds and the increased complexity of state-level income reporting. Adding to the challenge, recent changes to state sales tax and income tax laws further impact organizations that sell emerch across multiple states.

Area of Effect—The Wayfair Ruling

On June 1, 2018, the US Supreme Court ruled in South Dakota v. Wayfair that states may charge tax on purchases made from out-of-state sellers even when the seller doesn’t have a physical presence in the state. The court overruled its 1992 decision in Quill Corp. v. North Dakota where it had agreed North Dakota couldn’t impose a sales tax requirement on an out-of-state retailer who didn’t have a physical presence (i.e., office, store, or employee) in the state.

Wayfair removes the physical presence requirement and allows a state to impose sales and use tax on a remote seller. States may now apply nexus simply when emerch from outside the state sells in the state. These fairly new economic nexus laws require sellers across state lines to collect, report, and pay taxes on all sales including online and special event sales.

The high court’s decision to eliminate the physical presence rule has significant implications on income taxation of gaming companies, esports teams, and professional gamers. More than half of US states have adopted sales- or market-based sourcing. A seller of emerch with no nexus in a state could end up having state income tax filing and payment obligations in states where their customers reside. Moreover, sales of emerch to customers in such states could similarly result in market sourcing to such state.

Next Level—Wayfair’s Impact on Emerch Sales Tax

Post-Wayfair, most US states with a sales tax in place enacted new tax nexus legislation changing how businesses collect and report sales tax. States now use a lower sales threshold and can apply a transaction minimum to impose tax collection.

Each state will independently set its sales or transaction thresholds creating a confusing landscape for income reporting. These thresholds are fairly low, impacting even smaller esports organizations, such as those with annual sales over $100,000, or 200 transactions, per year.

Counterattack—How to Comply in a Wayfair World

Complying with state sales and income tax laws will require knowledge of each state’s requirements where emerch is sold or customers access a game. While sales tax thresholds apply to annual activity, quarterly filings are generally required in each state. This may require additional expense in modifying accounting systems to comply with multiple states’ sales tax collection.

Emerch sellers need to proactively determine in which states they need to file and register with the revenue departments in those states.

Additional problems are presented for gaming companies, esports teams, and professional gamers who try to comply with market-based sourcing rules for income taxation. Unlike traditional businesses, gaming companies don’t necessarily know where their customers reside or access the gaming servers from. This leads to additional complexity when evaluating market-based sourcing. Unique approaches have been considered by some gaming companies; for example, some companies base their apportionment to different states (and internationally) solely based on population census data. Certain states have informally indicated that this is a “reasonable” methodology.

These issues are necessarily complex and each client’s situation needs to be independently analyzed.

Special Events—Conventions and Tournaments

Many esports teams and professional gamers travel to conventions and tournaments. Prize money is sourced where it was won in most states. Fortunately, many esport conventions are held in Nevada or other places with no income taxation.

Similarly, emerch sellers attend conventions and tournaments across the country to reach their customer fan base. Most states consider all sales taxable although the rules for sales at special events vary from state to state. Emerch sellers must register in advance for a special event vendor license and is responsible for collecting and remitting tax on all sales made during the event.

End Game—The Overall Impact of Wayfair

State sales tax and income tax rules have changed. Gaming companies, esports teams, and professional gamers need to comply with the rules in multiple states, many of which they may have no physical presence in. The tax rules haven’t caught up to the unique compliance challenge of esports and gaming companies.

Esports organizations and sellers of emerch are encouraged to pursue tax advisory services to address all areas of sales and use tax. Bloomberg Tax Research offers a complete state-by-state chart of sales tax nexus, as well as an interactive sales-and-use tax nexus evaluator tool. If your business has questions related to state income tax, needs assistance in reviewing your nexus positions, or any other area of tax, please reach out to a tax adviser.

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.

Author Information

Paula Gustafson is a corporate tax specialist with law firm Nixon Peabody, focusing on tax litigation, corporate governance, compliance related to mergers and acquisitions, and emerging technology, including digital platform, mobile application, and online game development. She has an in-house background in game development and is an avid online player.

Shahzad Malik co-leads law firm Nixon Peabody’s Tax practice, focusing on tax issues in mergers, acquisitions, and venture capital transactions, as well as tax controversy. He has represented a number of gaming, digital media, and blockchain companies in merger and acquisition transactions.

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