Beginner’s Guide to SaaS Tax for Business Owners
There are currently 15,000 software-as-a-service (SaaS) companies in the U.S. These companies sell their software products, typically on a subscription basis, into states nationwide. Nearly half of all states collect tax on SaaS sales, requiring businesses to monitor, register, and report sales tax. Sales and use tax legislation is complicated, and tax laws on SaaS products are no exception. This article discusses how software is taxed and how your business can navigate the requirements.Jump To:
- How Sales Tax Applies to SaaS Products
- Current Software Tax Legislation
- Why Legislative Complexity Creates Blurred Lines
- In Which States Is SaaS Tax-Exempt?
- Subscription-Based SaaS Creates Nexus Nightmares
- Simplifying SaaS Tax Compliance
How Sales Tax Applies to SaaS Products
Software as a service (SaaS) is a form of cloud computing where the software is hosted by a third-party provider and delivered to customers as a service via the internet. In simpler terms, SaaS products are hosted in ‘the cloud,’ meaning they have no physical or tangible presence.
Current Software Tax Legislation
As is the case with all sales and use tax, states can develop their own rules and regulations around how to tax digital goods, including software.
The primary considerations that determine how software is taxed include:
- Whether the software is canned (one-size-fits-all) or custom.
- Whether the delivery is digital (download) or physical (disk).
- Whether the software stands alone or is bundled with services.
- What purpose the software serves (whether it’s for business or personal use).
- Where the seller and end-user are located.
- Whether the software is accessed via a cloud-based server.
Because SaaS is a cloud-based solution, it therefore fits into the tax equation in many states. However, multiple considerations listed above come into play when determining whether a specific software category or use case is taxable.
States that tax SaaS typically categorize it in one of two ways:
- As tangible personal property
- As a data processing or communication service, which is taxable in some states
Why Legislative Complexity Creates Blurred Lines
Even a cursory review of how SaaS is taxed and recorded by each state illustrates the complexity. Some states specifically spell out cloud-based software in their general guidelines for excise tax (a tax on goods, services, and activities). Other states have no detailed legislation. Instead, SaaS is casually mentioned in a fact sheet or bulletin that takes some determined web searching to surface.
A handful of states neglect to mention SaaS altogether. In this case, businesses must infer whether SaaS qualifies as “software delivered electronically” or something similar. Doubt surrounding this issue often prompts businesses to submit an inquiry to the department of revenue, and answers to these questions sometimes result in the issuance of an opinion letter. These letters offer unofficial guidance, but they give businesses a leg to stand on when assuming SaaS tax is not required—at least until further legislative details are put in place.
Fortunately, some states are more clear. For example:
- California, Colorado, Florida, and Indiana specify that cloud-based software is not tangible personal property, and therefore, is not taxable.
- Illinois and Georgia define SaaS as a non-taxable service.
- Kansas created its own category and term for SaaS providers, “Application Service Providers” (ASPs), which are non-taxable.
When a state overtly says cloud-based or electronically delivered software is exempt from sales tax, businesses can generally have confidence that legislation is concrete enough to be reliable.
In any other case, businesses have to use their best judgment based on information provided in legislative rulings, tangible personal property definitions, opinion letters, and tax bulletins.
In Which States Is SaaS Tax-Exempt?
These 26 states currently consider SaaS to be tax-exempt:
- Arkansas (Regulation GR-25)
- California (Revenue & Tax Code §6006)
- Colorado (Code of Regulations 60-310)
- Florida (Rule: 12A-1.032)
- Georgia (LR SUT-2014-05)
- Idaho (Code §63-3616(b))
- Illinois (86 Ill. Adm. Code 130.1935)
- Indiana (Information Bulletin #8)
- Kansas (Opinion Letter No. O-2010-005)
- Kentucky (Sales Tax Facts 2020)
- Louisiana (Revenue Ruling No. 10-001 and suspension of ruling)
- Maine (list of taxable services)
- Michigan (Department of Treasury Notice, January 6, 2016)
- Minnesota (R. 8130.0500, Subp. 2)
- Mississippi (Rule 35.IV.5.06 - page 56)
- Missouri (Rev. Stat. §144.010)
- Nebraska (Information Guide 6-511-2011—currently being updated)
- Nevada (Rev. Stat. §372.060)
- New Jersey (Technical Bulletin TB-72)
- North Carolina (SUPLR 2014-0010)
- North Dakota (Cent. Code §Sec. 57-39.2-02.1)
- Oklahoma (uniform tax matrix)
- Vermont (Stat. Ann. tit. 32 §9701)
- Virginia (05-44 Tax Commissioner Ruling)
- Wisconsin (Sales and Use Tax Treatment - Computer Hardware & Software)
- Wyoming (Wyo. Stat. Ann. §39-15-103)
Additionally, five states don’t have any sales tax: Alaska, Delaware, Montana, New Hampshire, and Oregon.
Many states don’t tax SaaS because they don’t consider cloud-based software to be tangible personal property. Others have more creative reasoning behind why SaaS isn’t taxed, focusing on how it’s served and stored or whom it’s used by and where.
Subscription-Based SaaS Creates Nexus Nightmares
Subscription-based SaaS products tend to operate on a rolling period. That means payments come in every day of the month, and there’s no clear start or end to billing cycles. As a result, businesses can find it can be extremely difficult to predict when nexus will be triggered. In particular, factors like seasonality and churn impact the amount of money the business must pay into a state in any given month.
Simplifying SaaS Tax Compliance
Most businesses don’t have the resources or desire to monitor and read endless legislation, tax bulletins, and court case rulings to determine where they owe SaaS tax. Legislation changes frequently, and it requires extreme diligence to stay up-to-date on what's happening across 50 states and the District of Columbia—and to verify that what you’re reading is accurate.
Simplify the process by requesting a no-cost economic nexus sales tax compliance risk assessment. Fill out this quick form, and we’ll send over a report that flags any areas of concern and will help you get on a path to compliance.Continue reading “Sales Tax Compliance for eCommerce Businesses”