There is no uniform answer yet

Is an AI service taxable? The answer depends on a tangle of highly technical distinctions that vary by jurisdiction. 

These are some of the criteria states are already applying, and getting them wrong can create real exposure: 

• How is the software delivered? 
• Does the customer download it or access it remotely? 
• Who owns the underlying infrastructure? 
• Is the AI component the primary deliverable, or is it incidental to a broader service?

Indiana’s decision

Indiana recently issued one of the first concrete rulings on AI taxability, and it landed in favor of the business. The state determined that generative AI chatbot services are not subject to sales tax because customers access the software through a website or app rather than downloading or owning it. Since the access involved no permanent ownership or local installation, Indiana treated the AI chatbot as a nontaxable service.

This is consistent with a long-standing distinction in Indiana's tax code: remotely accessed software is not taxable unless the customer receives tangible rights or a local copy. Indiana's ruling applied that traditional framework directly to a new category of product. For businesses whose AI tools operate entirely in the cloud with no local software component, this offers a useful early signal.

Kentucky is going a different direction

Indiana's ruling does not mean the question is settled. Kentucky has moved to clarify that AI software qualifies as taxable prewritten software, regardless of how it is delivered. That is a meaningfully different interpretation, grounded in a different view of what the transaction actually is.

This divergence is already happening, and it will only widen as more states weigh in. A compliance posture built on the assumption that remotely accessed AI services are universally nontaxable will break down quickly as states with more expansive definitions of prewritten software issue their own guidance.

Why the technical criteria matter more as AI gets more sophisticated

Indiana's framework relies on three core questions: how the AI is delivered, whether the customer owns anything, and whether the AI component is the primary deliverable. These work reasonably well for a standalone chatbot. They get harder to apply as AI is embedded more deeply into platforms.

Consider a SaaS product that adds AI-powered features to a core workflow. The software is accessed remotely, so under Indiana's logic it might not be taxable. But if the AI functionality is what the customer is primarily paying for, a state with a functionality-first approach, like the standard applied in recent New York and Tennessee software rulings, might reach the opposite conclusion. As AI becomes a core part of how software products deliver value, the line between "AI as a feature" and "AI as the product" is going to get harder to draw.

The exposure is growing faster than the guidance

More states will follow Indiana and Kentucky with their own rulings. Each one will make choices about delivery method, ownership, and classification that may not align with the last. For businesses offering AI tools, the obligation to track and respond to that guidance is real today, even though the guidance itself is still sparse.

The technical nature of these distinctions is part of what makes this category difficult. Whether your product is taxable may come down to architecture decisions, not just how you describe the product in your pricing page. Compliance teams that are not already asking those questions are behind.

What to do before more rulings follow

Audit how your AI tools are delivered and classified. Remotely accessed versus downloaded, owned versus subscribed, primary deliverable versus embedded feature: these distinctions are what states are using to make taxability determinations right now.

Track state-level AI tax guidance actively. This is not a space where annual reviews are sufficient. Indiana and Kentucky ruled within the same general window and reached different conclusions. The pace of new guidance will accelerate.

Pressure-test your compliance posture across the states where you have customers. A product that is nontaxable in Indiana may be taxable in Kentucky, and the next ruling may shift the picture again in a third state. Cross-state exposure assessments need to account for that variability explicitly.

The window for getting ahead of this is still open. If you want to talk through how these changes affect your specific products, our team is here to help.