While software as a service (SaaS) has quickly revolutionized our lives, it is still a fairly new way of doing business. Due to the heavy emphasis on digital transactions, many states’ sales tax laws haven’t kept up with this new technology.
Like many of your business’s tax responsibilities, filing sales taxes depends on where you conduct your business activities. So what’s the deal with SaaS taxability? Let’s go over what you’ll need to know about state to state sales tax as a SaaS business owner.
SaaS Tax Treatment: The Wild West of Sales Tax Law
U.S. sales tax has been around since the 1930’s when states, suffering through the Great Depression, needed creative ways to raise revenue. Back in those days, most sales transactions took place at brick-and-mortar stores.
With the rise of eCommerce, SaaS, and other new business models, states have struggled to either apply those laws to new paradigms or update existing tax code.
Forty-five states and Washington D.C. have a sales tax, and right now they treat SaaS taxability in an assortment of ways. In many states, only “tangible personal property” is taxable, so since SaaS isn’t tangible, SaaS providers aren’t required to charge sales tax. In a handful of states, services are considered taxable and therefore so is SaaS. In others, state departments of revenue have issued specific guidance when it comes to SaaS.
Here’s a handy map that depicts which states currently do or do not require SaaS business owners to charge sales tax:
Source: TaxJar maintains a living list of the most current state laws pertaining to SaaS taxability.
Basic Sales Tax Guidelines for SaaS Businesses
If you’ve developed a SaaS product, you will need to determine whether or not to charge sales tax to your customers. Here are some general guidelines to follow:
Identify where you have sales tax nexus
Sales tax nexus is a fancy way of saying “significant presence” in a state. If you have nexus in a state, that state requires you to charge sales tax to buyers in that state. Factors that create nexus for SaaS businesses can include a location such as an office or warehouse, an employee, contractor, or salesperson, inventory or an affiliate. But this is where things can get complicated for SaaS businesses.
From a state’s point of view, if your organization uses resources in the state, then the state can require you to collect sales tax. Since SaaS is so new, states are still trying to define what can legally create nexus. For example, some states now say that leasing space on a server in the state creates nexus, even if the business has no other presence there. (Source: Bloomberg BNA Survey of State Tax Departments, p. S-30.)
In addition to sales tax, having nexus in a state may tack on additional filing requirements. This article explains tax responsibilities that vary across states such as income, franchise, and gross receipts taxes. If you’re unsure whether or not you have tax nexus as a SaaS business, it’s always a good idea to consult a sales tax expert.
Once Tax Nexus is Established, Follow These Steps
1. Register for a Sales Tax Permit
Once you’ve determined you have sales tax nexus, your next step is to register for a sales tax permit in that state (or states). In most states, it’s unlawful to collect sales tax before your permit is in place, so be sure to do this first.
When you register, your state will assign you a filing frequency (usually monthly, quarterly, or annually) and sales tax filing deadlines. Sales tax filing frequency is generally based on volume. The more sales tax you collect in a state, the more often you’ll be required to file and pay sales tax. Be sure to pay attention to any communication you receive with your sales tax registration, because deadlines can vary quite a bit by state.
2. Collect Sales Tax
Once you’re registered in your nexus states, the next step is to start collecting sales tax from customers. Your payment processor may help you collect sales tax, or you may need to find a solution to collect SaaS sales tax.
Sales tax “sourcing” can be another point of contention for SaaS providers. In a few states, you are required to charge sales tax at the original point of the sale. But in many states, you are required to charge sales tax based on your customer’s location. With that in mind, when choosing a SaaS sales tax solution, be sure you’re using the right “sourcing” method for each of your sales tax nexus states.
3. Report and File SaaS Sales Tax
When your sales tax filing due date rolls around, it’s up to you to report how much sales tax you collected from customers in each nexus state. Most states don’t want a lump sum. Depending on state sourcing rules, they also want you to break down how much sales tax you collected from your SaaS customers in each county, city, and special taxing district.
This is where a sales tax automation solution can come in handy. A good solution will do everything from collect the correct amount of sales tax from your SaaS customers to creating a ready-to-return sales tax report. Some even auto-file your sales tax returns in most states, so you never have to look at a sales tax filing form again!
And that’s it, once you’ve collected sales tax from your customers in your nexus states and filed your sales tax return, you’re done with sales tax until the next due date rolls around.
What’s Next for SaaS Taxability?
As the SaaS business model becomes increasingly popular, you can be sure that more and more states will try to find ways to tax it. Stay tuned here for updates as each state passes new laws or issues new letter rulings on this hotly debated topic.
Do you have questions or something to say about SaaS taxability? Start the conversation in the comments!
TaxJar is a service that makes sales tax collection, reporting, and filing simple for more than 5,000 online sellers. Try a 30-day-free trial of TaxJar today and eliminate sales tax compliance headaches from your life!