Do I Need to Pay Sales Tax for a SaaS Company?
If you are operating a SaaS company or planning to launch one, you may be wondering if the company is required to pay sales tax in the USA. The answer to this question is not a straightforward one. Whether you are required to pay sales tax on SaaS depends on the digital goods and/or services you supply, to whom you sell your goods and/or services, where your customers are located in the USA (which state), and how much business you do with customers in that state. To add to the possible stress this may cause your accounting team, you should know that tax laws change every year, so you will need to reassess the situation annually.
Now, let’s review the basics and some ways you can efficiently and effectively determine if a SaaS company is required to pay sales tax.
Is SaaS taxable in the USA?
Yes, SaaS is taxable in the USA. Regardless of whether the SaaS services and goods are sold in a brick and mortar store or online, they may be taxed based on a number of factors. To decide if a SaaS company is responsible for paying sales tax, you must determine if it is taxable in each of the 50 states.
Federal and State Tax Laws
Currently, there is no federal tax on SaaS. This may be a huge relief for a business that is concerned with special taxation on goods and/or services that can be delivered in a variety of ways. However, federal taxation is not your only concern. Each state has its own tax laws and rates. So, you must assess your tax status on a state-by-state basis.
U.S. states can tax goods and services that are not taxed by the federal government. They are not required to administer taxation of SaaS companies in a uniform way or using a standardized tax schedule. Instead, they individually decide how they are going to tax SaaS goods and services in their jurisdiction. In the case of South Dakota vs. Wayfair (138 S. Ct. 2080, 2018), it was decided that if a SaaS company had an economic nexus with a state, the state could require it to pay sales tax. An economic nexus was defined as a financial connection to the state that was equal to or greater than US$100,000. Currently, US$100,000 is the tax registration threshold for most states. Note, there may also be some additional tax thresholds based on the SaaS revenue earned in some states.
The financial relationship could be the result of goods and/or services provided by the SaaS company to its customers in that state, online or offline. Translation, if a SaaS company has US$100,000 or more of revenue coming from the provision of goods and/or services delivered in any way to people or businesses in a specific state, that state may require the SaaS to pay it a sales tax.
Note, not all states tax SaaS companies, and states may differ on which SaaS goods and services they tax. So, to understand the tax status of a SaaS firm, you must know what it sells, how it sells it, to whom it sells, and how its offerings are classified under that state’s tax code.
Tax Assessment Considerations
Let’s look at the major factors that must be considered when determining the tax liability of a SaaS.
Types of SaaS Offerings
There are different types of software-related offerings, and they are treated differently by the tax authorities. The different types of offerings are:
This kind of software is created for specific or niche customers.
This is general use software that is bought off-the-shelf at a store.
Upgrades & Maintenance Agreements
SaaS companies generally offer software upgrades, coding error repairs, and program enhancements to their customers. They may be free or require the customer to pay a fee to have access to them.
This software is downloaded or accessed via a platform created by the SaaS company. This is what is generally referred to when people talk about software as a service, better known as SaaS.
Professional services are any services, for free or a fee, that the SaaS company provides to its customers. The services may be bundled with its digital products or sold separately. These kinds of services include integrating the SaaS tech into its customers’ existing systems, training on the tech, and providing repair services.
B2B vs B2C
SaaS tax liability is also assessed based on the nature of the transaction. If a SaaS company is selling its goods and services to businesses that will resell them, it is not required to pay a sales tax. Note, the businesses that plan to resale the SaaS firm’s goods and services must give the SaaS company a resale certificate. The resale certificate states that the company purchasing the SaaS goods and services will resell them and pay taxes on them after they are sold.
If the SaaS is selling its goods and services to end users, then it may be required to pay a sales tax. Whether it is required to pay a sales tax depends on the state’s tax laws, its economic nexus with the state, and how its goods and/or services are classified by that state.
Some states do require that SaaS companies pay a use tax. The use tax is paid by the purchaser, not the SaaS company.
Penalties for Failure to Pay Sales Tax for a SaaS Company
If a SaaS company is tempted to ignore the required sales tax or not bother figuring out if it is required to pay one, that is a terrible idea. A SaaS company that fails to remit and collect the required sales tax may be subject to financial penalties levied by the state’s tax authority. The penalties may include the payment of unpaid sales tax, interest on the unpaid sales tax, and fines. Furthermore, if the company chooses not to collect sales tax from its customers (if required by law to do so), then the company may be held liable for that too.
General Guide for SaaS Sales Tax in the USA
Below is a table of the states that tax SaaS and how it is taxed in different states.
|States where SaaS is Taxable||Alabama, Arizona, Hawaii, Iowa, Maine, Mississippi, New Mexico, New York, Pennsylvania, Rhode Island, South Carolina, South Dakota, Tennessee, Texas, Utah, Washington, Washington D.C., West Virginia|
|States where SaaS is not Taxable||Arkansas, California, Colorado, Florida, Georgia, Idaho, Illinois, Indiana, Kansas, Kentucky, Michigan, Minnesota, Missouri, Nebraska, New Jersey, North Carolina, Oklahoma, Vermont, Virginia, Wisconsin, Wyoming|
|States where SaaS for Personal Use is Taxable||Louisiana, Maryland, Massachusetts|
|States where SaaS for Business Use is Taxable||Nevada, North Dakota, Ohio|
|Special Note||Connecticut taxes SaaS for personal use at 4% and business use at 1%.|
Sales Tax Permits
If a SaaS company is required to pay sales tax in a state, it must register for a state sales tax permit. These permits can be applied for online or through the U.S. Postal Service (USPS).
In the alternative, the company can register under the Streamlines Sales Tax (SST) Registration System. The SST was created to simplify the sales tax system and make collection of sales tax easier for the states. Currently, 24 states are part of the SST and use its sales tax agreement. To use it, companies need only register for it, and they will get the required identification number and permit.
Failure to register for a sales tax permit is considered tax fraud.
Tax Compliance Strategies
There are three ways that companies manage their sales tax requirements. They may choose to manage their sales tax liability themselves, use a third-party service, or depend on software created for that purpose.
In-House Sales Tax Management
Some companies hire an accountant or sales tax expert to deal with the company’s sales tax liabilities in each state in which the SaaS does business. This person or department must stay up-to-date on the sales tax laws in each state, tax court decisions, and how the company’s offerings are classified in each jurisdiction where it does business. This way of managing tax liability is expensive, time-consuming, and the SaaS company bears all the responsibility for any errors made by its staff.
Third-Party Professional Service Providers
Other SaaS companies choose to use professional service providers who specialize in sales tax compliance. These companies go through their clients’ business records and determine what their tax liabilities are in each state in which they operate. They can save a business time, money, and stress because they have the personnel, resources, and expertise to efficiently and correctly do the job. Plus, they may indemnify their clients if there are errors made in the work. Meaning, the indemnified company will not have to pay any fines or fees assessed by a state in which the third-party service provider made an error.
Sales Tax Software
Sales tax software bought off-the-shelf or accessed online is the cheapest option. The company can hire someone to purchase the software, install it, and use it to calculate the firm’s sales tax throughout the year or at the end of the year. If this method is chosen, the company should purchase software from a business with a good reputation, and that regularly updates and maintains its software. Note, companies that sell canned software usually do not indemnify their customers.
Sales tax payments to each state a SaaS company operates in can be difficult to calculate. There are many variables to consider, and the tax code can be confusing for people who don’t specialize in taxation. Nevertheless, this tax must be paid if a SaaS company is operating in states where its goods and services are taxed, and it meets the state’s tax registration threshold. Furthermore, the financial penalties, owed taxes, and interest on unpaid taxes are often a sufficient deterrent for most companies to take the issue very seriously and avoid being in violation of the jurisdiction’s tax laws.
If sales tax liability, calculation, or assessment is a concern for your company, contact the Free Cash Flow Agency and discuss your concerns with their professionals. They provide the expertise, skill, and up-to-date knowledge that are of the utmost importance to you.