It may come as no surprise that “Software as a Service” (SaaS) is one of the most complex areas of taxation, especially when operating in the United States.
In today’s digital age, SaaS is a booming profit machine. However, where there is SaaS, there are likely complex taxation issues.
For starters, there are over 10,000 taxing jurisdictions in the United States. Operating and selling in multiple states and localities can trigger different sales tax obligations. Since SaaS is often cloud-based and can be accessed and purchased virtually anywhere, it can be confusing and tiresome to understand and comply with every applicable state sales tax law.
What makes SaaS particularly complicated is how each state classifies and subsequently taxes various software products.
Unlike tangible software (like C.D.s) or digitally delivered software downloaded onto a computer, SaaS is a type of software that “sits on” a provider’s server and is accessed by users via the cloud. Similar services include Infrastructure as a Service (IaaS) or Platform as a Service (PaaS). Each of these may be defined and treated differently for tax purposes.
Users from all over the country typically purchase a software subscription through internet servers. And since every state has a different view on the taxability of SaaS, it can be challenging to determine where to collect sales tax. Source Advisor specialists can help you understand your state’s tax rules for SaaS.
Companies that sell their services via digital products and software-related services likely have taxable transactions that fall under SaaS. Subsequently, these businesses may need to adhere to specific state sales tax requirements.
SaaS is not always listed as a taxable piece of tangible personal property (“TPP”), nor as a taxable service, making it tricky to determine taxability.
Many states have deemed SaaS a taxable service, meaning SaaS is mentioned explicitly in the state’s statutory and/or regulatory guidance. Other states, however, have ruled that SaaS is a taxable non-enumerated service. So, even though SaaS isn’t cited in the state’s statutory or regulatory guidance, some states rule that SaaS is taxable, classifying it as a taxable non-enumerated service.
So who should you collect sales tax from? You will need to determine where you sell your products to find out!
First, you will need to identify every state where your company sells SaaS. Then, you will need to determine how each state classifies software. Today, about twenty-one states tax SaaS no matter how the product is used. However, several other states tax SaaS differently depending on whether the tool is used for business or individual use.
Software can be classified as either prewritten (“canned”) or custom, both falling under the category of a digital product. However, the taxability of software hinges on whether the software is canned vs. custom.
Custom software is exempt from tax when it is significantly designed for, changed, or altered per the client’s direction. On the other hand, prewritten or canned software (sometimes referred to as “off the shelf” software) is standard and has limited customization. These transactions are subject to tax.
However, every state treats sales tax differently. For example, in New York, SaaS is considered a taxable service while California generally exempts the sale of SaaS. Other states may have different rates when it comes to the sale of SaaS or only exempts it when purchased for business use.
States are constantly evolving and changing their rules to keep up with the growing digital era. So, it’s only a matter of time before every state includes clarification in their statutory or regulatory guidance.
Now that you know the complexities around where you might be curious about when to start registering and collecting sales tax in each state.
Knowing when to collect sales tax starts with understanding your nexus. Nexus is the connection between a state and a business entity. If a business is determined to have nexus in a particular state, that means the company has a sufficient presence in the state to create sales tax obligations. Nexus can be created through a physical presence in a state or by selling remotely into a state (i.e., economic nexus). Other forms of nexus include click-through, marketplace, and affiliate nexus.
Besides having a physical presence, the obligation to collect and remit sales tax is usually triggered by the number of transactions and/or dollar amount in sales you have in each state. While state thresholds can vary, most have adopted a standard 200 transactions or $100,000 in sales.
Once a company meets a physical presence or economic nexus threshold, the company must collect and remit sales tax to that state on every taxable sale.
Advancements in technology have made it easier to tackle sales tax compliance. However, before you begin, it’s important to understand sales tax requirements for every state you do business. Every company is different, so selecting the right compliance strategy that fits your needs is critical to saving time and internal resources.