IRS Issues Final and Proposed Regulations for Digital Content and Cloud Transactions

In January 2025, the IRS and Treasury issued a long-anticipated package of guidance aimed at clarifying how digital content and cloud transactions are classified and sourced for U.S. tax purposes. This update has significant implications for technology clients, especially those with cross-border operations or complex service models. As trusted advisors, CPA firms must understand these changes to help clients remain compliant and tax-efficient.

What’s Included in the Guidance Package

The IRS guidance includes three key components:

• Final Regulations (TD 10022) clarifying how digital content and cloud transactions are characterized and sourced
• Proposed Regulations (REG-107420-24) introducing sourcing rules for cloud transaction income
• Notice 2025-6, which invites public comment on whether these rules should be expanded beyond international tax provisions

Final Regulations: Key Takeaways for Advisors

The final regulations expand upon the longstanding framework for computer software, now applying it to all forms of digital content. Key updates include:

• “Predominant Character” Test Replaces De Minimis Rule:
  Instead of splitting treatment based on minor transaction elements, the new test classifies bundled transactions—such as those offering both download and streaming access—based on the primary value delivered to the customer. This simplifies how CPAs and clients should evaluate the nature of these transactions.
• Sourcing Rule Based on Billing Address:
  Electronically delivered copyrighted content (e.g., software, media) must now be sourced based on the customer’s billing address—not where the content is downloaded or installed. An anti-abuse rule applies when transactions are structured to avoid tax obligations.
• Cloud Transactions Are Services, Not Leases:
  All cloud-based transactions—regardless of how they’re delivered—are now treated solely as services. This removes the previous ambiguity of dual classification as both services and leases.

The final rules apply to tax years beginning on or after their publication in the Federal Register. However, taxpayers may elect to apply them retroactively to years starting after August 14, 2019, if eligibility requirements are met.

Proposed Regulations: Sourcing Cloud Transaction Income

CPA firms with clients operating SaaS, IaaS, or platform-based models should be aware of the newly proposed sourcing methodology, which introduces a three-factor formula to allocate cloud income between U.S. and foreign sources:

1. Intangible Property: Based on R&D and amortization expenses
2. Personnel: Based on employee compensation tied to cloud activities
3. Tangible Property: Based on depreciation or rent of cloud infrastructure

This taxpayer-specific approach streamlines reporting by excluding intercompany allocations while including guardrails against base erosion or artificial sourcing shifts.

These proposed rules will apply to tax years beginning after the final regulations are issued.

Why This Matters for Your Clients

This guidance marks a significant evolution in how digital transactions are taxed, with ripple effects across tech, media, and SaaS clients. CPAs should begin assessing client exposure under these new rules—especially those with international footprints or multi-element digital offerings.

Additionally, CPA firms may want to advise clients to participate in the IRS comment process outlined in Notice 2025-6, particularly those with concerns about further expansion of these sourcing rules.

Need Help Interpreting the Rules?
McGuire Sponsel’s Global Business Services team can help you and your clients navigate these complex updates and prepare for implementation. Reach out to us for technical guidance or a client-specific review.