Sales tax for software companies: what to know as you grow
- Dec 5, 2017 | John Sallese
The five-year growth plan for your software company likely looks — at least partially — like this: hiring new workers and contractors, creating relationships with new vendors, expanding your online presence, growing into new markets, increasing your footprint, and perhaps even pursuing a financing event or exit strategy.
Here’s something else to add to the mix: managing the new sales tax obligations that result from all that growth. A 2017 survey found that the average software company engages in nine growth activities a year that trigger new sales tax responsibilities. Responsibilities like:
- Collecting sales tax on more transactions
- Complying with the rules and rates of more states
- Tracking taxability rules for more products and in more jurisdictions
Plus you have to update your invoicing and accounting systems to handle it all. It’s a downside of growth, for sure, but one that isn’t insurmountable. The key to successfully navigating your changing sales tax responsibilities is this: Identify the sales tax triggers in your growth plan and create a future-forward sales tax strategy to address them before they occur.
This graphic highlights the triggers you’re most likely to encounter, as well as some questions to help you identify them and understand the accompanying challenges.
It’s important to examine your growth initiatives from a sales tax perspective. You’ll probably uncover a host of complexities when you do. If not, you may not be looking close enough.
Today, for example, it’s critical to think outside the traditional concept of physical presence as a basis for establishing a sales tax responsibility with a state. Sure, expanding your footprint with additional headcount, sales staff, partners, or offices in other states can increase your sales tax obligations. But 17 states now have affiliate or “click-through” nexus laws (as of August 2017) that don’t require a physical presence to create tax liability. That means participating in affiliate programs or online advertising is enough to trigger a new sales tax responsibility that your organization has to manage.
Also complex: knowing what’s taxable (and at what rate) and what’s exempt. It changes from state to state. Many states (actually half of them) also now require online sellers to collect sales tax on ecommerce transactions — some include digital software downloads in that group and some don’t. And more and more states are taxing services, such as software setup support, more often.
At each stage of your growth, your sales tax responsibilities grow right along with you. It’s important to know when you’re creating new responsibilities and to have a plan in place to address them.
Being proactive with your compliance will set you up for success in a number of areas. The more up to date you are with compliance, the less likely you are to encounter audit penalties. Getting sales tax right can also have a positive impact on a financing event or funding process, as investors look at sales tax compliance as part of your overall financial health.
Go deeper into sales tax considerations for the growth events highlighted above by downloading Part 1 of our in-depth series, The Software Executive’s Guide to Sales Tax.