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Sales and Use Tax and the SaaS Business Model

  • Learn
  • Dec 2, 2015 | Suzanne Kearns

Software as a Service (SaaS) has revolutionized the way people use software, both individuals and business owners alike. In the past, when people needed specialized software, they had to shell out big bucks for it, but now because of SaaS, even the smallest of businesses can use just about any type of software in the cloud.

But this new way of doing business has created sales and use tax challenges for states.

SaaS Sales Tax Issues

The biggest challenge for states trying to determine whether or not to tax SaaS business models is how to classify the transactions. Typically, states characterize sales transactions as either tangible personal property or services, but the SaaS model doesn’t neatly fit into either category. In most states, tangible personal property is taxable, while most services aren’t. The issue with business models like SaaS is that it has elements of both categories.

Which leads to another issue -- there is no uniform classification of the SaaS business model because states classify it differently. Most states charge sales tax on prewritten software because they consider it tangible property, but when it’s used in the cloud, states differ on whether or not to call it tangible.

For instance, New York authorities argues that SaaS should be taxed because accessing software applications via the cloud constitutes constructive possession of tangible personal property in which customers gains the right to use, control, or direct its use.

However, a recent case might call that ruling into question. In the SunGard case, an administrative law judge initially ruled that the company’s SaaS product was not subject to sales tax because their SaaS service was part of a greater whole of services. In addition its employees were heavily involved in the process, which means they directed the customer’s actions while using the software.

A higher court eventually ruled that SunGard is responsible for collecting the tax, but other courts are finding the opposite. In fact, Florida, Georgia, Massachusetts, Tennessee, South Carolina, Virginia, and Wyoming have all ruled that SaaS is not taxable. Some states, like Colorado, don’t consider SaaS as tangible property and don’t require sales tax on it. Other states, like Ohio, argue that SaaS is not personal tangible property, but tax it under the service category. The rest of the states are way behind the curve and haven’t even considered the question.

What Does It Mean to You?

So how do you determine whether or not you owe sales or use tax on SaaS in each state? First, you should determine whether or not you have nexus in the state, which is tricky when it comes to SaaS. For example, if you rent a server in a state to store your software, you might have nexus in that state.

Next, you’ll need to contact each state’s Department of Revenue to learn about their SaaS sales and use tax regulations. The laws are quickly changing, so it will require due diligence on your part to keep up.

Finally, you could avoid all the confusion and use a sales tax SaaS to determine the taxability on your SaaS. Still have questions? Our state sales tax guides can help answer common sales tax questions.

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