Sales taxes can be confusing, especially for SaaS companies in the United States. Although it is convenient and profitable that SaaS products can be sold online to wherever there’s Internet access, it can be very tricky when it comes to staying compliant with local tax laws.
How SaaS taxes work in the U.S.
In the U.S, there is no federal sales taxes. Businesses have to pay state sales taxes based on local rules and regulations. This means the company needs to do research and learn about sales tax laws in the state or region they conduct business in.
The United States breaks software into three categories: Tangible software, downloadable software, and software accessed via the cloud.
- Tangible software: the technology product is sold in a physical form (in a box or something as such). For example, floppy discs or CDs are considered tangible software.
- Downloadable software: the technology product is sold in digital form through a software license that allows the customer to download the product.
- Software accessed via the cloud: the technology product provides a service that can be used via remote access through the cloud only. Customers cannot download the software.
If your business provides a service through software accessed via the cloud, the U.S. classify your product as SaaS.
Where is SaaS taxable?
As each state has its own regulations on tax eligibility for SaaS products, we’ve helped you outline a list of states and their sales taxes rules for SaaS. You can click on each state to look at specific sales tax regulations of that state.
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 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 with specific regulations for SaaS personal/business use:
Personal use is taxable in Louisiana, Maryland, Massachusetts.
Business use is taxable in Nevada, North Dakota, Ohio.
In Connecticut, SaaS for personal use is taxed at full rate in the state, while SaaS for business use is taxed at only 1%.
Tax Nexus and Types of Nexus for Online Sales
What is tax nexus?
The term “nexus” in tax laws is used to describe the connection between the taxing authority and the tax-paying entity when a business has a tax presence in a specific state.
Historically, a business has a nexus in a state when it is physically in the state one way or another. However, it is now determined more loosely. A business may have sales tax nexus in a state when:
- It has a physical address in the state.
- It has property within the state (intangible property is included).
- It has employees working and residing in the state.
- It has employees who solicit business in the state on a regular basis.
Types of nexus for online transactions
- Click through: This occurs when a purchase is made through a link or a website, which is referred to the customer by a business and that business is paid a commission. For example, an ad campaign that focuses on direct sales would require nexus and would not if focuses on lead generation.
- Economic: When the business meets a threshold in sales, it must pay sales tax. If sales fall under the threshold amount, tax is not required.
- Affiliate: When someone who is not an employee or independent contractor (outsourced) but actively associated with the business and make sales on the company’s behalf, it is entitled to nexus.
Grow with sales tax automation
As your SaaS business grows, your customers can be anywhere, and so is your sales tax nexus. If you are not a tax expert, it is safest to automate the process and make sure you are compliant to the local tax rules. Congero Techonology Group would like to guide you through this tax automation process, with our partner Avalara who provides a software that makes tax easier to manage. Talk to our experts about how we can help you with a seamless tax automation process.
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