SaaS taxability: A comprehensive guide

How do states look at SaaS (software as a service)-oriented businesses and sales tax requirements? The short answer is, “Many ways.” The longer answer is, “Many, many, many ways.”

The complexity of sales taxes and SaaS is a confluence of factors, including almost a decade of upheaval in states’ tax statutes and the advent and lightning development of what’s become everyday technology (and how the technology is delivered). The result can befuddle tech and SaaS companies that only want to stay ahead of their sales tax obligations.

Nexus

This comes in two forms, and, without this, a company has no obligation to a sales tax jurisdiction.

One type of nexus is physical – an office, reps, warehoused inventory in a state – and historically this was the nexus most companies had that linked their business to a sales tax jurisdiction. In 2018, though, the Supreme Court decided in South Dakota vs. Wayfair that “economic nexus” allowed states to mandate remote, out-of-state retailers to collect and remit sales tax. Of the 45 states that impose a sales tax, all now have economic nexus laws, as does the District of Columbia.

Nexus has impacted tech companies significantly. For example, before 2018 a tech company in Ohio might have had customers and offered remote installation and services all over the country, but because the company only had physical presence in Ohio, it only had nexus in that state. Economic nexus clearly changed that.

We recommend that any company (including tech and SaaS) with $100,000 in sales of taxable goods during a 12-month period in a state investigate the likelihood that it has economic nexus in that state. Another threshold in a dwindling number of states may be a company’s quantity of transactions.

Failure to do could result in an audit by a state and a company being assessed the tax it should have charged – with no statute of limitations.

Digital goods and taxability

“Digital goods” refers to goods sold, delivered and transferred in digital form. In most states this means music, movies and books. Other states also include pictures, streaming video and information services and software. (This is not an exhaustive list, just examples.) The challenge in the tech space is that tech advances so rapidly – and sales tax jurisdictions’ statutes are certainly not keeping up with the products offered and how those products get to customers.

Technology taxability varies significantly: information services incurs sales tax in 13 states; software delivered electronically incurs it in 34 states. Eighteen states tax SaaS or cloud-based solutions, a number that has grown and shrunk over the last couple of years. Subscriptions and downloaded software as delivery methods can also create sales tax obligations, but this can also hinge on how a tech company presents the charge on an invoice.

Some states exempt SaaS from taxation, but this too varies widely. Connecticut, for instance, taxes SaaS but at a rate much lower than the state’s general sales tax. New Jersey doesn’t tax SaaS but does tax downloaded software unless that software is sold to a business. South Carolina doesn’t tax downloaded software but does tax SaaS, exactly the opposite of many states. And in Texas, SaaS is treated as a data processing service, meaning that 20% of the charge is exempt.

Additional details

Local jurisdictions’ statues can matter, too. In Illinois, downloaded software is generally taxed but there are five criteria to make it exempt, with factors including contract terms, the ability to resell the services or even whether the agreement was physically or electronically signed. Also, SaaS isn’t taxed in Illinois, but it is in Chicago.

Sales tax situs determines what state’s tax applies. Situs is the location in which a taxing event occurs; for many products of tangible personal property, this means either the billing or the ship-to address. For SaaS, situs can be where the “benefit of use” occurs. This means situs depends on where the customer is who uses the SaaS, not on the location of the company selling the product. Also pertaining to tech, the location of the server can determine situs, which matters for sales tax obligations in states like Utah and Florida.

Vertical services related to digital goods, such as consulting or installation/ implementation/configuration, could also be taxable. Generally, though, if downloaded software is exempt in a state, these also are exempt. If downloaded software is taxable, these are still not necessarily taxable, too. Customization can be tax-exempt, especially if it’s separately stated on the invoice. Exemptions of maintenance charges can depend on whether the maintenance is optional or mandatory.

Clearly SaaS is one of the more complicated products/services for sales tax, even in the already-complex world of tech. For more, see our SaaS taxability map or our “Tax Talk” webinar, “Sales Tax for SaaS & Tech.”

We can help you stay on top of the ever-changing world of sales tax rules. TaxConnex is an outsourced sales department that can take the burden of sales tax off your plate. Contact us to learn what it means when sales tax is all on us.