The Ultimate Guide: how us sales tax work for saas businesses
An Overview Of Sales Tax For SaaS Products In The US
Every time a SaaS provider sells a product, they must abide by the local sales tax regulations in the area where the product was bought. This means that companies must be familiar with every single sales tax regulation in every state, province, nation, and location where they do business.
Inaction may lead to tax evasion, penalties, and possibly jail time.
Terrifying, to put it mildly!
Although there are numerous nations in the world, the United States is a hub for the sale of technology. Nearly all SaaS businesses operate exclusively within the United States. To remain sales tax compliant, though, is difficult due to the size of the nation and the variety of its sales tax legislation. As a result, all SaaS businesses selling goods in the United States must be aware of the state-specific sales tax regulations.
If you manage a SaaS business, read the information below to make sure you adhere to all sales tax regulations in the US.
What does the SaaS product in the US mean?
Software in the US is divided into three categories: tangible software, downloaded software, and cloud-based software. Knowing how each is classified can help you determine whether your product falls within the SaaS category.
- When a technology product is sold to a consumer in a box or another container, the term "tangible software" is used. Tangible software includes CDs and traditional floppy discs offered by big-box stores.
- A software license that enables a customer to download a technical tool directly to their local hard drive is referred to as downloaded software.
- A new classification for software in the United States has been created to include SaaS items. This kind of software is a tool that a user receives through the Internet; it is often referred to as a cloud service or a SaaS product.
Determine US sales tax for SaaS businesses
Great! Now that you are aware that your organization is categorized as a SaaS business in the US, what should you do?
It's time to check to see if you have to add any sales taxes.
State-by-state variations exist in the US sales tax. The taxability of SaaS goods is a topic on which each of the nation's 50 states has its own position. However, there is a precise technique you can determine whether your SaaS business needs to collect sales tax in the United States.
Make sure your product is recognized by the US as a SaaS tool (as mentioned in the section above), and then do the following actions to determine whether you must charge your clients sales tax:
- Make a note of every state where your business distributes SaaS products.
- To determine which of these states recognizes a "nexus" on software companies, see if they adhere to the click-through and affiliate nexus standards or the more traditional physical presence standards.
- A nexus, often referred to as a sufficient physical presence, in the United States decides whether enterprises operating outside of a state that sells goods into one are required to collect sales tax on a range of goods.
- Court rulings on nexuses attempt to uniformize sales tax within a particular state.
- A state where you've sold your goods will have one of five taxable software classes if it has a nexus with software enterprises. Two of the five could be relevant to your SaaS company, depending on the state. Find out which of the following taxes are charged in the jurisdiction where you conducted business:
- Taxes on sales of prepackaged software delivered as tangible personal property
- Because they are regarded as "software solutions that cannot be updated or altered beyond their initial functionalities," SaaS products may be considered canned software in some jurisdictions.
- Custom software provided on tangible personal property is subject to sales taxes.
- In several areas, custom software may now incorporate SaaS enterprise software.
- Check to see if your SaaS-classified product comes under either of the two categories of software that the state where you've conducted business recognizes.
- If that is the case, you must collect sales tax from every SaaS product you sell there.
What Are Sales Taxes, Sales Tax Regulations, And General Rules For SaaS Companies
SaaS firms must first clarify their position with regard to "nexus." Different states have different economic and physical nexus activities. SaaS providers should be aware of their nexus status because, without it, they may be submitting their tax returns in error.
For the avoidance of doubt, "nexus" simply refers to a company's sufficient link to a certain taxing authority. Depending on the products or services that a corporation sells, nexus will ultimately determine whether it has a collection and filing duty to a taxation jurisdiction.
This definition can vary by state because each one handles taxes in a unique way.
Companies that have a "physical presence" in their state are referred to as having a physical nexus. In some states, businesses are said to have an economic nexus if they conduct a minimum number of sales transactions or earn a minimum amount of revenue within the state in which they are headquartered.
Breakdown: A General Overview Of SaaS Taxability
Software as a service ("SaaS"), which refers to cloud-based applications, is frequently taxed differently in each state. Additionally, governments have developed a variety of interpretations for this service, which frequently further complicates an already complex tax situation.
For instance, "canned" or "prewritten" software may be sold as tangible personal property (TPP) in some states. In that instance, taxation is applicable to the software. Similarly, these states might similarly handle SaaS in a similar way. Similar to when software is downloaded to a computer, the consumer is using the software in the same way.
The legislation of a state typically trails technological advancements. Software that is given electronically to the consumer is still not regarded by a few states as a sale of tangible personal property. A SaaS product is also exempt from taxation in some states because no physical hardware is needed to use the software.
Since the consumer doesn't own the program but is instead using it via a subscription, another interpretation that a few states have come up with is that SaaS might be seen as the rental of tangible personal property. In that instance, taxation is applicable to the software.
Another view, which is exclusive to a few states, holds that SaaS refers to the offering of computer and data processing services.
B2B v/s B2C SaaS
The taxes associated with B2B and B2C SaaS differ significantly.
Why? they aim to serve entirely distinct customer bases. While B2C SaaS businesses primarily promote to and sell to people, B2B SaaS enterprises market and sell to registered businesses. Of course, there are instances where customers mix and match, but this is more unusual than not.
The state and the way your business model is identified are other factors. In order to properly file and send taxes both within and beyond state lines, both types of SaaS businesses need to be aware of the appropriate tax jurisdictions in their respective states.
What Should Be The Preparation Checklist For Sales Tax On SaaS
The Tax Preparation Checklist
Overall there are five steps to prepare for your SaaS sales tax. It includes:
- You need to begin gathering invoicing data on a state-by-state basis as soon as possible, and you should keep track of your progress in relation to the state-specific thresholds.
- The pricing and sales teams should be made aware of this well in advance. Excessively communicate this. Everyone dislikes surprises.
- Make sure your back office has the procedures for collection, remittance, and tax compliance, and that your invoice processes can calculate the sales tax.
- Before crossing the line, register with the relevant states. Call the state taxing authority on the phone. They can help you every step of the way and, more significantly, provide you with advice on when you should begin collecting. I've been pleasantly delighted when the state taxing authorities suggested that I wait a little bit longer on occasion.
- Automate the operation. Many SaaS-focused sales tax automation vendors can interact with your billing and accounting software. They efficiently prepare the returns and send the taxes in.
Why Are SaaS Business Sales Taxes Complex
The term "Nexus" describes the degree of affiliation between a certain taxing jurisdiction and a company when discussing sales tax regulations in the United States. The entity in this situation is the business itself, and the taxation jurisdiction can be either a state or a district. A taxation jurisdiction has the authority to charge taxes to SaaS firms after this connection has been made.
Physical and Economic Nexus
Any company with a significant physical presence in a given jurisdiction must pay taxes there, according to the concept of physical nexus. This presence may involve owning property there or employing people to work there.
A certain level of economic activity is referred to as "economic nexus," after which a company is required to pay taxes in a specific jurisdiction. This is typically assessed in terms of a predetermined monetary amount, the total number of transactions during a given timeframe, or both.
Differential state and state regulations
Since there are currently over 14,000 tax jurisdictions in the United States, each with its own rates, laws, and regulations, managing taxes is extremely difficult and time-consuming.
Every state in the United States has a different sales tax law with a varied base rate. Then, on top of that, any authority within a state may impose additional taxes. For instance, a district may levy yet another tax on top of the two already in place, and a county may impose an additional sales tax.
As a result, the sum could be much more than the standard state rate.
Distinct states may have varied evaluation windows and registration deadlines, as well as different sales criteria. SaaS founders and leaders must research the nexus legislation in each jurisdiction due to these complications.
New Products and Services
Software, SaaS, and digital goods companies are infamous for having difficult tax situations. Your sales tax nexus may undergo complex modifications each time you add a new good or service to your lineup. There are many different categories and criteria used to tax software, and the system hasn't always kept up with advancements in technology.
No of their experience level or size of business, business owners will be confused and frustrated by the fact that things can be taxed at various rates based on who bought them, where they got them, and whether the item is taxable in a specific state or jurisdiction.
Multiple state return filing
You must register for sales tax in each country where you have nexus; there is no getting around it. As previously indicated, this can require you to keep track of various filing requirements and deadlines for many states.
Different states have different filing requirements. Additionally, depending on how much business you do in a particular jurisdiction, you could need to prepay some or all of your sales taxes.
In conclusion, it frequently becomes obvious very quickly that if you have nexus in several states, it can be too much for you to handle internally.
Differing taxable periods
Due to the fact that every state establishes its own tax seasons, some will prefer that you file your taxes annually, while others would ask you to do so quarterly or monthly. Another reason to think about getting outside assistance with your taxes is dealing with the various taxable period requirements, which can be intimidating.
It is advisable to stay on the side of caution and make sure that qualified specialists are handling this area of your business if you are unsure about your ability to manage all aspects of tax compliance.
What Are The Major Key Considerations When Scaling Up Your SaaS Business
Key Considerations To Grow & Expand SaaS Business
For each state, your business registers in, a sales tax identification number will be provided to you. But make sure you comprehend all state income tax duties before registering your SaaS or software company!
- Taxable Items
- B2C v/s B2B
However, B2C tax cases are increasing, so as time goes on, you'll pay more in B2C taxes. Many legal systems do not distinguish between B2B and B2C transactions in terms of taxes. If you are unsure, it is recommended that you speak with a tax expert.
- Tax Rate and Threshold
Last but not least, keep track of your tax payments and tax credits. The odds of success in all business operations will also rise if you are audit-ready.
- Filing and Sending
- Penalties for Failure to Comply
Be cautioned that the consequences can range from backdated payments and fines to criminal prosecution depending on whether there appears to be malicious intent or not.
- Changing laws
Final Key Takeaways
In this chapter, we will recall the final key points associated with US Sales tax working with SaaS businesses.
Let’s Recall Some Important Points
Nowadays, it is easy to sell goods and services abroad. SaaS products, for example, can be purchased online and sold wherever there is Internet access. The intricacy of local tax legislation is the biggest issue that is brought about by this, even while it gives tech companies new opportunities.
Software-as-a-service is currently the most popular and well-known software paradigm in the industry. This has affected the tax laws and regulations in numerous states during the last few years.
All you need to do is just keep a check on the latest rule and regulations for SaaS businesses as per your state. Additionally, to grow and expand your business, you need to consider some points like:
- State regulations
- Taxable products
- Threshold limit and tax rates
- Filling and remittance
- Penalties for late filing
- The updates in the state rules