Software, SaaS and Sales Tax

By Robert Dumas on Tue, Feb 22, 2022 @ 11:15 AM

paperwork_2

If your business sells software or software-as-a-service (SaaS), you deal with one of the most complex sales tax situations, potentially without even realizing it. Your sales tax obligation and liability begin with where you have nexus, a connection between your company and a taxing authority or jurisdiction. Sales tax nexus was once defined only as a substantial physical presence but for almost four years – ever since the Supreme Court’s Wayfair ruling – sales tax nexus can also be defined as an economic presence resulting solely by selling into a state. 

Regardless of whether you have sales tax nexus or not, many businesses assume that sales tax doesn’t apply to software or SaaS. But, over the last few years many states have changed their tune on the taxability of technology, digital goods, software and Saas.  

Special delivery 

What is “software” anymore? How is it delivered? Are there maintenance or support services included? Are those services optional? These questions all factor into determining whether sales tax applies to these discreet revenue streams. 

SaaS is currently the predominant delivery method for tech/software companies, followed by electronically downloaded software. Fewer companies continue to deliver software via a tangible medium, like a CD. 

Each delivery method can have a different sales tax treatment in each of the states.  

Software delivered via CD still has the most states that tax it, while electronically downloaded software has fewer. SaaS has the least number of states that tax it, although that doesn’t mean you can ignore sales tax. SaaS is currently taxable for sales tax purposes in roughly half the states. That’s still a lot.  

Why isn’t taxability more uniform?  

Easy: States tax each category individually. In other words, one state may tax software delivered physically and also tax SaaS but not tax software downloaded electronically. Another state may tax SaaS but not downloaded or physically delivered software. 

Then there are nuances within some states. For instance, Connecticut taxes SaaS, but at a reduced 1% rate when sold to a business. Texas exempts 20% of the SaaS charge but applies the standard sales tax rate to the remaining 80% of the charge. Then there is Colorado which exempts SaaS at the state level but many of the home-rule jurisdictions including Denver do tax SaaS. 

Illinois doesn’t tax SaaS but does generally tax sales of downloaded or “canned” software. Chicago, which considers SaaS a lease of personal property, does tax SaaS – a reminder that local and home-rule sales tax laws also have to be kept in mind state.  

The future of sales tax on SaaS (Software as a Service) or software was a hot topic in many states last year. Mississippi has proposed expanding the state’s sales tax to cloud computing. A bill in Georgia aims to impose the state’s sales tax on digital goods and services (without specifically repealing a law that exempts sales of prewritten software delivered electronically or “by means of load and leave”).; Hawaii clarified when its general excise tax applies to software sales.; North Carolina gave a SaaS licensed a break on sales tax because customers don’t receive a tangible copy of or an electronic download of the software as part of a subscription fee.

The side dishes 

Ancillary products and services – hardware, customization, implementation, maintenance contracts and so on – have their own unique tax treatment. 

Hardware, for example, falls into the category of tangible personal property, and all states with a sales tax treat the sale of hardware as a taxable event. A maintenance agreement might be treated differently for sales and use tax purposes depending on whether it’s mandatory or optional. 

Your best bet is to check with an individual state’s taxation or revenue department or to consult a sales tax specialist. 

Location, location, location

The tax situs is the location in which a taxing event occurs. Tax situs can affect both nexus determination and taxability determination for SaaS businesses. 

Let’s say a company has a customer in New York (which taxes SaaS) but the customer has individual users accessing the software from all over the country – not all of the users are in New York. From a sales tax perspective, you have to consider where the benefit of use is received. In this example, the benefit of use is received where the users are located. 

But this creates several questions and issues. Do we really know from where a customer’s users are accessing the software? Do we have nexus in all the states from where a customer’s users are accessing the software? What is the tax treatment in each of the states from where a customer’s users are accessing the software? 

As a result of this level of complexity, many businesses choose to apply tax based on the business bill-to address. A customer’s multiple-points-of-use exemption – attesting to certain users being outside a state or tax jurisdiction – can also relieve you of the obligation to charge sales tax on the entire invoice. 
 
Not realizing your sales tax obligation or not acting on a growing obligation could have big repercussions for your business (see our checklist for more). Be sure you continually monitor taxability laws and your economic nexus thresholds as you add new clients. 

TaxConnex has assisted companies in many industries alleviate the burden of sales tax. We are experts when it comes to navigating tax regulations. Contact us to learn more about how TaxConnex can take sales tax off your plate entirely.   

Looking for more information on sales tax for your business and have 30 minutes to spare? You can watch this replay of our 30-minute webinar session – Tax Talk with TaxConnex – Taxability of Digital Goods or Service

Or check out our SaaS map to ensure you aren't out of compliance in any states that tax SaaS! There may be more than you think - 

SaaS taxability map cta

 

Robert Dumas

Written by Robert Dumas

Accountant, consultant and entrepreneur, Robert Dumas began his public accounting career on the tax staff at Arthur Young & Co., followed by a brief stint at Grant Thornton. In 1998, Robert founded Tax Partners, which became the largest sales tax compliance service bureau in the country, and later sold it to Thomson Corporation. Robert founded TaxConnex in 2006 on the principle that the sales tax industry needed more than automation to truly help clients, thus building within TaxConnex a proprietary platform and network of sales tax experts to truly take sales tax off client’s plates.