Published February 5, 2025
A Complete Guide to Sales Tax for SaaS Companies
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Since the early 2000s, software as a service (SaaS) has been a rapidly growing industry which has boomed in cities such as San Fransisco, Chicago, Atlanta, even the OG headquarters of The Sales Tax People in Dallas, Texas as well as our newfound HQ in Lehi, Utah have all seen tremendous growth in the tech and SaaS sector. Companies such as Adobe, Zoom, Salesforce have been able to grow rapidly fast under the SaaS business model.
To break it down simply, because SaaS companies make sales of their service product, yes, they may be liable for collecting and remitting sales tax to the state. However, SaaS and sales tax is a relatively new conversation for many state legislations, and regulations surrounding SaaS continue to change from state to state. These changes coupled with the constant challenge of each individual state having their own separate sales tax law, complicates the answer to this question tremendously.
States can vary dramatically in their approach to SaaS and sales tax liability. Understanding how each state perceives the taxability of your service as well as how and when your business could trigger sales tax nexus are things you need to understand earlier than later to avoid costly penalties while growing a SaaS business.
In this article, we'll cover everything SaaS companies need to know about sales tax.
To understand how sales tax works with SaaS, you first have to understand the tax-based definition of SaaS. For tax purposes, SaaS is defined as delivering applications via the internet instead of downloading them directly on a machine. Instead of software that is bought once (usually as a physical disk) and downloaded to a single device, SaaS turned software into a service that customers subscribe to for continual access and capabilities. The software is hosted in one place and then licensed to users via a subscription model. SaaS is also commonly known as web-based, on-demand, or hosted software.
Because SaaS involves customers making a purchase, it is taxable. SaaS is considered a service and not a product. However, whether or not SaaS services are taxed and their tax rate varies by state. In general, states that tax other services (like beauty services or entertainment) also tax SaaS, and states that don’t tax services don’t tax Saas. But there are often exceptions to the rule, and regulations are constantly changing (especially as SaaS evolves), so it’s important that every SaaS company understands its sales tax liabilities in every state it has nexus.
(this may or may not be true for your individual business for a variety of reasons)
But like we said, sales tax and SaaS can get really complex. For example in the following states SaaS is taxed in some instances and not in others:
Like all types of sales tax, a company needs to establish a sales tax nexus in a state before it has to pay sales tax (if SaaS is taxable in that state). Because SaaS services can easily be bought by customers in different states beyond just where the business is headquartered, it’s common for SaaS companies to have nexus in multiple states.
A company can establish different types of nexus in various ways, but any type of nexus requires the business to pay sales tax:
States have different levels of what it takes to establish economic nexus. The most common threshold is $100,000 or more in sales in the state in a year, but that number varies for each state and could even be coupled with a threshold related to the number of transactions your business has in the state.
A growing complication in establishing nexus is the increase in the number of remote workers. In general, a company has nexus if it has employees in a state. However, with more employees working remotely (especially in SaaS), a company can have one or two remote employees working in dozens of states. What does that mean for nexus? As usual, it varies by state. In many states, having a remote employee in the state qualifies a company for economic nexus in the state and makes it responsible for sales tax, if applicable.
Like any other type of taxable business, any SaaS company that establishes nexus needs to register in that state. This process may differ depending on whether or not the company is based in the state (essentially, if it established physical or economic nexus). However, in most cases, it involves registering for a sales tax permit by completing forms and submitting information about the business, such as identification information and what types of services the business sells. Some states may require a small registration fee.
To collect sales tax, a business needs to calculate the sales tax rate in each state and add that percentage to the purchase price. In states where SaaS services are taxable, sales tax should be applied to one-time purchases and recurring subscription purchases. In most states, the frequency of remittance depends on how much sales tax is collected — the higher the amount, the more often companies need to pay.
To stay compliant, companies must keep records of their sales tax collection and remittance. This includes keeping searchable records of every transaction and sales tax amount, as well as copies of sales tax returns and payment information.
Sales tax is complex and can be even more complex when special considerations are added for some SaaS businesses.
Because sales tax is collected at the state level and not at the federal level, businesses should consider each state as a separate process. Each state has its own taxability for services and tax rates. That means companies can copy the basic steps (calculating, collecting, and remitting sales tax), but the specific steps and tax rates will differ in each state. Failing to calculate based on each state’s unique tax rate and process can lead to fines and other penalties.
Other countries may not collect sales tax, but businesses are still responsible for following the proper procedures for international sales. If a business has a physical nexus in a state because it has employees or an office there and sells from that state to an international client, it needs to calculate and collect sales tax on the services sent from that state.
Bundled services are still services that can be taxed in certain states. If a customer bundles SaaS services for business and personal use, for example, but lives in a state where only business SaaS transactions are taxed, then they only have to pay sales tax on that portion of the sale. Bundled services can make calculating sales tax more complicated, especially in states with some variance in their service taxability.
When it comes to calculating and collecting sales tax, technology is one of the best resources a business can have. Tax calculation software can automatically calculate sales tax amounts on various purchases and make adjustments based on tax rate changes or taxability.
Many technology solutions integrate with billing systems to seamlessly calculate and collect sales tax at the point of sale. And with automation, businesses can take out the manual guesswork of collecting sales tax. Technology is a powerful tool, but human oversight is still wise, especially with changing sales tax regulations.
Sales tax comes with a level of risk because of the complex calculations and compliance requirements. If a company is found out of compliance with its sales tax, it will likely be required to pay back past-due taxes (perhaps with interest) and may be subject to fines and other penalties.
The most common compliance pitfall is not keeping accurate transaction and tax collection records. Leveraging technology tools can help streamline the data collection process and keep information organized, which is especially useful for audits. Companies should also periodically evaluate their sales tax process and strategy to ensure they are calculating information correctly and keeping accurate records.
SaaS is a continually growing and evolving industry, and its sales tax regulations and requirements also continue to change. It’s crucial that companies don’t settle into how things are now, as a future state will likely bring new changes to taxability, rates, and processes.
Some states only tax SaaS for personal or business use, but not for the other. Some only tax SaaS products that are downloaded, but not those that are used via the internet. As the SaaS industry evolves and changes, these regulations may also change to match industry trends and changes.
Understanding the ins and outs of SaaS taxability can be challenging, especially when operating a business in multiple states. The dedicated team at The Sales Tax People specializes in providing comprehensive sales tax services. Our in-depth knowledge and strategic approach help you navigate the intricate landscape of sales tax regulations, ensuring compliance and peace of mind. Contact us to learn how we can support your business.
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