Saass sales tax

When most people think of sales tax, they only consider the sales tax charge on purchases of physical items. But nontangible purchases can also be subject to sales tax. In recent years as more work has moved into the electronic realm, the question of whether or not software and Software as a Service (SaaS) is subject to SaaS sales tax has become more frequent.

So is SaaS subject to sales tax? The answer is that it depends on which state the purchaser lives (or works) in. this applies to software used for business and personal purposes.

Explained: State Sales Tax on SaaS (Software as a Service) 

The federal government does not have a general sales tax. Instead, sales tax is levied at state, county, and city levels. 

How is SaaS Taxed at the State Level?

The sales tax on SaaS varies from state to state. Currently, 22 states levy some form of sales tax on SaaS. In addition, each state has its own definitions for items subject to sales tax.

Some states consider SaaS services, and if the state taxes services, then SaaS would also be taxable. In other states, services aren’t taxable, making SaaS nontaxable. Finally, the third category of states considers SaaS software and imposes any applicable software sales tax on SaaS. 

Understanding how each state you operate in and sell in taxes SaaS is key to remaining compliant with all applicable laws.

Do I Owe State Sales Tax for SaaS Sales? 

Whether tax is required or not on a state-by-state basis is dependent on whether a SaaS has a “nexus” in a particular state. Unfortunately, determining whether or not you’ve created a nexus in a specific state can be confusing.

Nexus was originally defined as a “substantial physical presence” by the U.S. Supreme Court in Quill v. North Dakota in 1992. But in a digital world with substantial interstate commerce, the definition has been updated and adapted to meet the realities of modern commerce.

The definition of physical nexus has remained basically unchanged, although having remote employees in a state may create a physical nexus for a business. Economic nexus is created when a company reaches a specific number or dollar values of sales in a particular state. 

Depending on the state, you’ll need to pay taxes to not only the state where you have physical nexus but also other states where your customers are based, and you have created an economic nexus. 

What States Charge Sales Tax on SaaS

SaaS sales tax by state 2022

Software-as-a-service is taxed in 22 states (map) noted below. The states marked as differently have specific rules related to SaaS taxation. 

  • Alabama
  • Alaska
  • Arizona
  • Connecticut (differently)
  • Hawaii
  • Iowa (differently)
  • Louisiana
  • Maryland (differently)
  • Massachusetts
  • New Mexico
  • New York
  • Ohio (differently)
  • Pennsylvania
  • Rhode Island
  • South Carolina
  • South Dakota
  • Tennessee
  • Texas
  • Utah 
  • Washington
  • Washington D.C.
  • West Virginia

Note that in the states listed above, SaaS may also be subject to local sales tax rates. 

How to Stay Compliant

SaaS is taxable even if you have not created a physical presence (nexus) within a state. Most software companies are subject to sales tax because of economic nexus rules. Therefore, you will need to carefully monitor your sales in each state and the ever-changing rules for economic nexus creation.

Compliance with sales tax rules is essential to avoid penalties and interest on unpaid sales tax. Depending on the state, penalties can range from 5% to 25% per month, along with interest of up to 9%. In addition, sales tax authorities for each state can audit your financial records and sales within your state to ensure compliance.

Though it can be expensive to submit all the necessary tax returns and ensure compliance, navigating a sales tax audit and the additional penalties and interest for underpayment of taxes is even more expensive.

Tips for Lowering Taxation for SaaS

Though you cannot avoid paying sales tax once you’ve created a nexus in a state, there are ways for SaaS companies to lower their overall tax burden.

  • To Offset Claim R&D Tax Credits
    • The IRS has a four-part test for companies to qualify for the R&D credit (and most software companies can be eligible for the credit):
      1. The activity must create a new business function or substantially improve existing processes.
      2. The activity must be technological.
      3. The activity must have the intent to improve the process.
      4. The activity must involve experimentation to achieve results.
    • The R&D credit can be significant and is often 6-8% of a company’s qualifying R&D expenses. This can more than offset any potential sales tax on software sales.
  • Avoid having a nexus in states that tax SaaS transactions. 
    • You should consider your potential clients when selling SaaS and try to minimize sales to state that tax SaaS transactions. If your potential client has multiple locations, consider selling your software to one of their locations within a state that does not tax software.
  • Keep nexuses to a minimum to avoid multi-state tax complications. 
    • Because some states impose an economic nexus after ten sales in the state, you may want to consider not offering your product in certain states. This will depend on the price tag of your product. Creating a nexus may be worth the hassle if you have a $500,000 annual licensing fee for your software. Creating a nexus may not make sense if your price tax is less than $100.

Final Thoughts on the Sales Tax for SaaS

Dealing with multi-state sales tax transactions can be complicated. You will need to carefully monitor your sales to determine when you have created a nexus in various states. You should also understand how each state imposes sales tax on software.

Remember that despite the hassle, you will create a significant problem later on if you do not adequately monitor your nexus in each state, file the appropriate (and timely) sales tax returns, and pay the proper taxes. You can avoid sales tax audits, but proving you are compliant can prevent hefty penalties and interest later on.

We have answers to your toughest tax questions regarding SaaS sales tax.  Reach out for a complimentary one-on-one tax strategy session with one of our pros. Click here to set up your free strategy session here.


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