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5 Steps to Determine Sales and Use Tax on SaaS Subscriptions

  • Dec 2, 2015 | Suzanne Kearns

With more and more individuals and business owners taking their IT functions to the cloud, sellers of Software-as-a-Service (SaaS) subscriptions are sitting pretty. After all, why should someone pay for a tangible software program when it’s so easy to use SaaS? In fact, it’s been reported that some analysts believe one-third of all new software in the next five years will be SaaS.

But one of the issues many sellers have when it comes to sales tax and SaaS subscriptions is whether or not their particular model is taxable. We’ve outlined some steps below to determine whether or not you should be charging sales or use tax for your SaaS subscriptions.

What Exactly is SaaS?

Before we get to the issue of taxation and SaaS subscriptions, let’s talk about what it is -- and isn’t. Software is typically broken down into three types:

  • Tangible software is software that is bought in a box or package and then installed on a personal computer. If you sell this type of software, you will need to charge sales tax if you have nexus in the states you sell it in.
  • Downloadable software is downloaded after a customer purchases the software or a license and most states also consider this type of software tangible -- and therefore taxable.
  • SaaS software is hosted on a server, and customers access and use it via the cloud and pay for the service. This is the type of software we’ll address in this article.

Do You Charge Sales Tax on SaaS Subscriptions?

Unfortunately, the process for determining whether or not to charges sales tax on SaaS subscriptions isn’t an easy one. That’s because every state views the product differently. Some states, like Texas, consider SaaS subscriptions taxable, while other states, like South Carolina, don’t.

Here is a five-step process that will help you determine if the states in which you sell SaaS subscriptions consider the service taxable.

  • Step 1: Do you have nexus? If you don’t have nexus in a state it won’t matter whether or not your SaaS subscriptions are taxable because you aren’t obligated to collect that state’s sales tax. Ecommerce sellers typically trigger nexus in a state by having some sort of physical presence like an office, warehouse, employee, agent, or store. You can check this list of state departments of revenue to determine the nexus rules in the states where you sell.
  • Step 2: How does the state classify SaaS -- as a product or a service? Some states consider SaaS a tangible product, while others consider it a service.
  • Step 3: Do you or your customers control the end product? This is one of the trickier issues when it comes to SaaS. Some states define their SaaS sales tax laws based on the answer to this question. For example, Wisconsin rules state that if the end user does not have access to or control over the server, SaaS is not subject to sales tax.
  • Step 4: If the state considers SaaS a product, is it taxable? Just because a state considers SaaS a product, that doesn’t automatically means it’s taxable. For instance, New Jersey considers the software a tangible product, but because it’s not transferred to customers, it’s not subject to sales tax.
  • Step 5: If the state considers SaaS a service, is it taxable? Just like with products, not all states that consider SaaS a service recognize it as a taxable service. For instance, Idaho considers SaaS a service that is not taxable.

Remember, if you sell SaaS subscriptions in many states, it would save time and effort to automate the process with an automated sales tax program. Have more questions about managing state sales tax? Refer to our state sales tax guides.

Sales tax rates, rules, and regulations change frequently. Although we hope you'll find this information helpful, this blog is for informational purposes only and does not provide legal or tax advice.
Avalara Author
Suzanne Kearns
Avalara Author Suzanne Kearns