Businesses selling Software-as-a-Service (SaaS) have historically had it easy when it comes to determining their sales tax liability in a state. The decision tree looked something like this: Collect sales tax in states where you have a physical presence (nexus); otherwise, don’t. Being that operating a SaaS business does not require a physical presence where the sale is being made, the sales tax liability was usually not a big factor. Those days are behind us as the U.S. Supreme Court’s decision in South Dakota v. Wayfair Inc., (“Wayfair”) handed down in June 2018, changed all of that.
The Wayfair ruling gave the green light for states to obligate sellers of SaaS products to collect sales tax regardless of whether they have a physical presence in that state. This ruling cemented the concept of an economic nexus, meaning a business can now establish nexus in a state by doing a certain amount of business in that state. Economic nexus thresholds are levels of business activity that when exceeded, automatically impose a tax collection obligation on remote sellers (sellers without a physical presence in the state). States vary and thresholds range from $100,000 to $500,000. For example, South Dakota’s economic nexus threshold requires sales tax to be collected by remote sellers after $100,000 of in-state sales OR 200 in-state transactions per year.
As you might imagine, the Wayfair ruling created a huge revenue potential for states, and many took swift action to implement law-making SaaS sales taxable. Of course, each state created its own unique tax law in this area, leaving businesses to hash out where they have nexus and whether a given product or service is taxable on a state-by-state basis.
Traditionally, from a sales tax perspective, states tax the sale of tangible personal property but not services. While many states adhere to that mantra, several states have moved towards taxing software despite being intangible in nature. Still, it can be difficult to determine whether SaaS is more like software, which may be taxable, or if it feels more like a service provided, which is not taxable in many states. States have been consistently inconsistent across the country in determining whether to tax SaaS. Further, different states often have similar statutes and reach completely different conclusions in their quest to analyze SaaS.
Once you’ve sorted out each state’s SaaS taxability as it pertains to your business, the next step is to ensure you understand the economic nexus threshold established by the state. Economic nexus thresholds now exist in over 40 states and business owners must track this for each state they do business in to ensure they are complying. It’s also wise to periodically review each state’s laws to make sure nothing changed, and you didn’t get the memo. If you aren’t 100% sure where you have exceeded nexus thresholds and whether you are selling a non-taxable service or taxable software in each state, you could be exposing your business to huge tax liability.
Situs Issues for SaaS
Just because you aren’t located in the state where your exposure is, doesn’t mean you’re safe from that state’s tax audit and collection program. This is due to another complicated area of sales tax law requiring that sales be sourced in order to determine which state(s) have the right to tax the transaction. In the past, the destination of a tangible good was used to determine the state with taxing authority over the transaction. With SaaS, there is typically no tangible good or product destination to make this determination with, so states improvise by determining situs on the location of host servers or the location of the end-users.
If you provide SaaS or cloud computing and sell it into other states, an analysis might be in order. Further, if you have offices out of State and use cloud computing, it probably makes sense to investigate before you get that dreaded audit notice from another state.
At Sales Tax Helper we help those needing expert representation and defense during sales tax audits, protests, and administrative litigation. More importantly, we provide services equivalent to tax attorneys at the price of a sales tax consultant. Simply put, this is what we do, and we will work hard to reach a reasonable resolution for your business’s sales tax liabilities. We welcome the opportunity to answer all your questions and handle your sales tax issues!