Selling in the US as a software company

In 2021, 264 million people made online purchases in the U.S. likely due to the country's strong consumer culture. It’s also one of the biggest digital markets in the world, with computer software sales reaching $587.6 billion (USD) in 2022. That’s without even counting other types of digital goods, such as games or music downloads.

While tax laws can form a barrier to trade, some software businesses have experienced great success by establishing themselves in states that exempt digital goods from sales tax. California’s Silicon Valley is a great example — it’s home to U.S.-based tech giants like Adobe, Apple, Meta, and Alphabet Inc.  

The U.S. market is highly tech-focused, and the country itself is a huge innovator in the field of automation, digital solutions, and ecommerce software. For instance, some of the largest social media platforms (Facebook, Instagram, Pinterest, Twitter) are U.S.-owned or based in the U.S.

While the complexities surrounding digital sales tax can make trading difficult, the potential benefits outweigh the challenges. Operating in the U.S. as a software business can hugely increase your revenue and stimulate growth, as long as you have a solid understanding of topics like digital sales tax and sales tax liability.

‘Nexus’ is the U.S. term for sales tax liability, and there are two kinds of nexus to be aware of. First, by operating in a particular state, you establish physical nexus — there are other triggers, but this is the most common. By reaching a certain value of sales (e.g. $100,000 worth of sales) a company establishes economic nexus. Having either kind of nexus means you need to remit sales tax to the relevant local authority.

Software companies are primarily digital. As such, they don’t need physical stores or warehouses to sell their goods, and don’t need to worry as much about having physical nexus — and thus sales tax liability — in multiple states. 

However, the introduction of economic nexus in 2018 meant having physical locations is no longer the sole deciding factor in sales tax liability. In fact, a software business well below the state’s economic nexus threshold might still have to collect sales tax if the business has a presence within the state’s borders, thus achieving physical nexus.

The United States taxes on a ‘benefits received’ principle, which means that when you’re investigating your potential sales tax liability, your first question should be ‘where are the benefits of these products being received’.  A software company must know where their product will be used so they can apply the correct tax. 

For instance, if you’re billing a business in New York, you need to know if they’re based there or just visiting. If the business is actually based in another state, there can be tax implications because digital sales tax varies between different states.

A great way to discover potential sales tax liabilities is to use our free sales tax risk assessment tool. It can clearly outline where your software company might have to pay taxes should you expand into the U.S.

The way the EU and U.S. define a digital good (for tax reasons) differ significantly. In the EU, there are four specific criteria that define a digital good:

1. It's not a physical, tangible good.
2. It’s based on IT, and could not exist without technology.
3. It’s provided via the internet or an electronic network.
4. It’s fully automated or involves minimal human intervention.

While these criteria are fairly accurate within the U.S., the American definition is not as definitive and varies between states. For instance, Colorado taxes most digital goods but exempts video games. In Illinois, the opposite is true. In Rhode Island and Indiana, digital photos aren’t even defined as software, so they’re tax-exempt.

There are five states that charge no general sales tax, and in addition, there are several states that specifically do not tax digital goods. The key to selling software in the U.S. without having to worry about tax compliance is research — you need to know how particular states are likely to apply digital sales tax. If you don’t have a strong background in U.S. tax law, you can contact Avalara for some expert advice.

Interested in more U.S. digital sales tax advice? Our latest whitepaper contains the five most important steps for European businesses selling into the U.S., as well as lots more useful information on navigating American tax law. You can click here to download the paper for free.