Avalara Resource Center

Software and sales tax

Software and technology strive to make the difficult easy. The opposite can be true for sales tax on software; it’s frustratingly complex and a drain on resources. Tax laws lag behind the industry, forcing states to rely on outdated or arbitrary rules to tax or exempt digital goods, and only a few jurisdictions have clear guidelines on taxing software as a service (SaaS). Your customers can be virtually anywhere, which means you can have sales tax nexus everywhere. This perfect storm of inefficiency and risk is putting pressure on software CFOs and finance leaders to rethink their tax compliance strategy to align with growth goals.  

Software taxability — why software companies have it the hardest

Digital downloads, cloud access, streaming media. This is how software companies go to market today. While consumers and companies adapted to this change quickly, tax authorities are still several steps behind. Some states call out digital goods and services specifically in their tax laws. Others group digital goods in with taxable tangible personal property. And still others have yet to update their laws, leading to a gray area that complicates compliance even more for software companies just trying to get sales tax right. This map illustrates the 450+ ways software is taxed across the United States and the insurmountable headache and complexity that comes along with getting tax compliance right.

Nexus and the software seller

Physical presence is no longer the only benchmark for creating sales tax nexus. More than two dozen states now have affiliate and/or click-through nexus policies in place and some states have introduced economic nexus, which bases the obligation to register, collect, and remit sales tax solely on sales revenue or transaction volume. A recent survey of software financial executives found these three activities most likely to trigger nexus:

  • Hiring employees and contractors in remote offices
  • Selling digital products and services in the cloud
  • Breaking into new markets with new products

While common in many industries, software companies engage in these activities more frequently and at a faster pace, which can trigger new tax obligations and further complicate compliance.

Higher profile, higher risk

Visibility is good for growth, but it can also shine a bright, relentless spotlight on your company’s finances. During financing events and IPOs, investors look closely at how business is managed. Poor sales tax management practices or unfavorable audit outcomes can impact valuation, jeopardize funding, or even nullify deals. Companies with a higher profile and higher revenues also tend to be chosen for audits more often. Several states even have nexus discovery units within their tax revenue departments that scour public information to find companies that are not compliant with state laws. Educate yourself on the risks and how you can avoid undue scrutiny.

Software is the ultimate tax solution for software companies (big surprise, right?)

Software companies tend to grow rapidly. Their business is constantly changing, which means their tax obligations are constantly changing too. Industry CFOs and controllers quickly realize they need a dynamic tax solution that can manage these changes efficiently without eating up resources. Manual back-end processes and outsourcing don’t have the agility and scale tax automation can provide. As a top 100 cloud company, Avalara is an expert in managing tax rules and regulations inherent to software and SaaS companies, and helps them achieve their compliance goals as they grow.