Sales taxes for SaaS are confusing. The red tape that defines our global tax system can weigh down any company. And it’s getting worse.
Products and services can now be sold internationally with ease. SaaS products, for example, live online and therefore can be sold wherever there’s Internet access. And while this provides new opportunities for tech companies, it also causes many issues, the most prevalent of which is the nuance of local tax laws.
Any time a SaaS company sells its product, it’s required to follow the sales tax laws in the region where the product was purchased. This means that businesses need to be aware of each and every sales tax law in each state, province, country, or region in which they conduct business.
Failure to do so can result in tax evasion, fines, and even jail time.
Scary, to say the least!
And while there are many countries in the world, the U.S. is a hotbed for technology sales. Almost every SaaS company does business within U.S. borders. However, the country is so big, and its sales tax laws so variable, that it’s a challenge to remain sales tax compliant. This means that all SaaS companies need to be aware of the state-specific sales tax laws for SaaS products sold in the U.S.
If you run a SaaS company, read the following to ensure you’re compliant with all U.S. sales tax laws.
What is a SaaS Product in the U.S.?
The United States breaks down software into one of three categories: Tangible software, downloaded software, and software accessed via the cloud. Understand the classification of each so you know if you’re product is considered SaaS.
- Tangible software refers to instances where a technology product is sold to a customer in a box or something similar. Traditional floppy discs and C.D.s sold in big box retailers such as Best Buy are considered tangible software.
- Downloaded software refers to is a software license that allows a customer to download a tech tool directly to their local hard drive.
- Software accessed via the cloud is a new U.S. classification that is meant to account for SaaS products. This type of software is a tool in which a customer accesses over an Internet connection, also known as a service accessed via the cloud or a SaaS product.
SaaS products do not allow for downloading. Instead, they access the software via remote access only. Some states denote this as either “canned or custom software delivered on tangible personal property,” and require sales taxes. However, some do not. If you have a cloud-based software tool that uses hosted application management or software on demand, you’re selling a SaaS product and need to be aware of U.S. state sales tax laws.
Determine U.S. Sales Taxes for SaaS Products
Great! So you now know that your company is considered to be a SaaS business in the U.S., now what?
Well, it’s time to see if you need to charge any sales taxes.
Sales tax within the U.S. varies by state. Each of the country’s 50 states has their own views on the taxability of SaaS products. However, there is a specific way in which you can verify whether or not your SaaS company needs to charge sales tax within the U.S.
First make sure that your product is defined as a SaaS tool by the U.S. (noted in the section above), and then follow the steps below to find out if you have to charge your customers a sales tax:
- Note each state in which your company sells a SaaS product
- Check which of these states recognize a “nexus” on software companies, which fall under either traditional physical presence or click-through and affiliate nexus standards
- A nexus in the U.S. is also known as sufficient physical presence and determines whether out-of-state businesses selling products into a state is liable for sales tax on various products
- Nexuses are decided by court opinions that work to standardize sales tax within a specific state
- If a state in which you’ve sold your product has a nexus that includes software companies, it will have one of five taxable software classifications. Of the five, there are two that may apply to your SaaS business, depending on the state. Find out which of these taxes are levied in the state in which you’ve done business:
- Sales taxes on canned software delivered on tangible personal property
- Canned software may include SaaS products in specific states because it is considered “software solutions that cannot be modified or altered beyond their original functionalities.”
- Sales taxes on custom software delivered on tangible personal property
- Custom software may now include SaaS enterprise software in some states
- Verify if your SaaS-classified product falls under any of the two software types recognized by the state in which you’ve done business
- If so, you’ll need to charge sales tax in that state for each SaaS product sold within the state
Verify U.S. Sales Taxes for SaaS products
We know that U.S. sales tax on SaaS products is confusing, especially when you try to break it down by state. To help, we’ve outlined all 50 U.S. states and denoted whether or not they require a sales tax on your SaaS product.
Did you know our software calculates sales tax on the fly? Test it out here on our free sales tax calculator.
However, each state classifies your SaaS product under any of the five categories above, and it’s important to verify the state-specific tax laws before charging a sales tax on the sale of your service.
List of states that do not levy a sales tax on SaaS products include:
- New Jersey
- North Carolina
- North Dakota
List of US states that have a sales tax on SaaS products include:
- New Mexico
- New York
- Rhode Island
- South Carolina
- South Dakota
- Washington, D.C.
- West Virginia
It’s important to note that Delaware, Montana, New Hampshire, and Oregon have no sales tax at all, regardless of product.
It’s important that your SaaS company applies the right sales taxes to the right U.S. states.
It’s up to you to be compliant, and you need to abide by the tax code of each individual state. If you do business in Texas, for example, you’ll need to charge taxes on the sale of your SaaS product. If you also do business in California, you have to ensure that you aren’t charging your Californian customers sales tax on the purchase of your SaaS tool.
The penalties against companies that don’t properly charge sales taxes within the U.S. are numerous. According to Criminal Defense Lawyer, a failure to pay state sales taxes can result in sales tax evasion, fines, and even jail time.
Don’t risk being non-compliant. Make sure you’re paying the proper sales taxes on your SaaS product for the U.S. states that require it.
Note: At Quaderno we love providing helpful information and best practices about taxes, but we are not certified tax advisors. For further help, or if you are ever in doubt, please consult a professional tax advisor or the Tax Agency.