Current state law defines taxable goods as tangible personal property, which excludes services and products accessed remotely over the internet, such as SaaS. The state imposes a base sales tax rate of 7.25% on sales of these goods, with some local jurisdictions applying their own, additional sales tax, but these rates do not generally apply to software companies.
However, businesses operating in California should still consider nexus rules, which determine whether a company has enough of a presence in the state to be responsible for collecting taxes and remitting those funds to the relevant tax authorities. Factors such as having employees, inventory, or significant sales in California can create tax obligations (more on nexus later in this article).
Keep in mind that SaaS sales tax regulations and requirements change frequently. And misunderstanding tax laws or failing to comply with them can result in fines, penalties, and even legal issues, so staying up-to-date is very important.
Taxation rules in California
California does not impose a sales tax on SaaS because it is not considered tangible personal property.
SaaS is accessed remotely through the internet rather than being physically delivered or installed on a customer’s device. Since there is no transfer of physical media, SaaS transactions fall outside the scope of taxable goods under California law.
However, if a company provides a physical copy of the software — for instance, on a CD or flash drive — the transaction may become taxable.
Other cloud-based services, such as Infrastructure-as-a-Service (IaaS), which provides access to virtualized hardware and storage, are also typically nontaxable, as long as there is no physical component involved. Custom software created specifically for a client is treated similarly, whether delivered digitally or via tangible means.
Taxability of other digital goods
Digital goods are non-taxable. However, digital goods that include a physical element, such as a printed manual or a storage device, is treated as taxable in their entirety.
Digital-only products, like e-books, photographs, and NFTs (non-fungible tokens), are usually not taxed when they’re transferred electronically. California law does not classify these items as tangible personal property, so they remain outside the scope of sales tax.
Businesses should be cautious, however, when bundling digital products with physical items or services, as such transactions might be partially or fully taxable.
Future taxation considerations
Staying informed about tax policies, even when they seem stable, is a proactive move for businesses.
While there is little indication that California plans to change its stance on SaaS taxation in the near future, tax policies often change as technology and business practices evolve. Anticipating these shifts before they happen allows businesses to remain compliant and ready for any updates to tax requirements.
Lawmakers and industry stakeholders occasionally revisit tax laws, especially as other states begin to tax SaaS and digital services more broadly. Keeping an eye on legislative updates and tax rulings is a smart move for businesses operating in this space, as changes could impact compliance requirements and pricing strategies.
Staying compliant in California
Unlike California, many states tax SaaS and digital goods, creating a complex patchwork of regulations for businesses to stay on top of and work around.
Certain states, like New York and Texas, treat SaaS as taxable, so businesses have to understand and work with differing rules and rates. In states like Colorado, SaaS is non-taxable at a state-level, but certain localities within the state will charge sales tax on software. For companies managing multi-state operations, this variability in regulations can present significant management challenges.
Nonetheless, it’s important to stay informed and proactive to avoid the penalties and pitfalls that can come with non-compliance.
The impact of nexus in California
Understanding the concept of nexus is key to remaining compliant. The term “nexus” refers to a business's connection to a state. Once a business has met a nexus criterion in a state, they are required to collect and remit taxes on taxable items. There are two types of nexus:
- Physical nexus: A business has physical nexus in a state when it has a physical presence there, such as an office, a warehouse, or employees. For instance, a growing startup that hires remotely nationwide may establish physical nexus very quickly.
- Economic nexus: Economic nexus is based on sales volume or revenue. For instance, if a business surpasses a certain amount in annual revenue on taxable sales in a year, it is obligated to collect sales tax. In California, that minimum amount is $500,000. Vermont, as another example, applies economic nexus laws with specific transaction thresholds, creating different obligations for SaaS businesses meeting those criteria.
Understanding how nexus works and tracking where it applies is essential for managing compliance across state lines. Taking these steps helps SaaS companies avoid unnecessary complications and maintain smooth operations in an increasingly digital economy.
Staying compliant nationwide
Properly navigating sales tax compliance across multiple states can be challenging for SaaS businesses, particularly in states where SaaS is taxable. Following a structured process helps avoid costly errors and potential penalties later on down the line:
- Register: Begin by obtaining sales tax permits in each state where your business has tax obligations, based on nexus laws. In California, this is known as a “Seller’s Permit,” which you can register for on the California Department of Tax and Fee Administration (CDTFA) website. The process involves providing basic information about your business.
- Collect: Next, you’ll want to accurately calculate the appropriate sales tax for each relevant transaction, properly accounting for state and local tax rates. While this doesn’t apply to SaaS in California, it’s still important to note for companies working in multiple states.
- File: Make sure to submit periodic sales tax returns to report taxable sales and the total amount of tax that was collected. Your particular fling frequency — monthly, quarterly, or annually — depends on the state’s requirements and your sales volume. You can easily file your sales & use taxes in California using the CDTFA website.
- Remit: Please promptly send the collected taxes to the respective state authorities, as any late payments may result in penalties or interest charges. You can pay your sales & use taxes online using the CDTFA website.
These steps, when followed consistently, help businesses remain compliant and avoid potential complications. As you can see, maintaining tax compliance can quickly become overwhelming for firms of any size, especially those currently operating in several states.
Fortunately, Numeral provides a practical solution to these various challenges, offering automated tax rate calculations, simplified reporting, and centralized tracking of state-specific obligations. SaaS companies using Numeral enjoy less administrative hassle and greater assurance in meeting tax compliance.
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Additional resources for staying compliant
Staying compliant with California's tax regulations requires accessing authoritative resources and educational tools. Below are key materials to assist in understanding and fulfilling tax obligations:
California government resources
- California Publication 109: This publication offers comprehensive guidance on internet sales and associated tax responsibilities within California.
- California Revenue and Taxation Code Section 6016: Defines "tangible personal property," which is essential when it comes to determining tax applicability.
- California Department of Tax and Fee Administration (CDTFA): The California Department of Tax and Fee Administration’s website is filled with resources and information on all things related to sales tax in the state.
Educational resources and tax help lines
- California Department of Tax and Fee Administration (CDTFA) Online Seminars: CDTFA provides pre-recorded videos and webinars covering various tax topics, including sales and use tax record-keeping, tailored for different industries.
- CDTFA Taxpayer Educational Consultation Program: This particular program offers personalized assistance to help businesses of all sizes understand their current tax obligations.
- Industry-Specific Resources: For SaaS businesses, understanding tax obligations can be complex. Thankfully, there are plenty of industry-focused guides online available that can help businesses understand their tax obligations.
Final thoughts
In California, SaaS is considered an intangible product and, therefore, is not taxable in the state. However, businesses that are currently operating in multiple states may encounter different tax requirements and thus should be aware of compliance requirements.
Physical and economic nexus criteria determine where taxes must be collected and paid. These requirements are essential to prevent fines and avoid compliance-related problems, including sales tax audits.
Tax rules are complex and can change frequently, especially as more states introduce taxes on digital goods and services. Regularly reviewing official state resources and tax updates helps businesses stay on top of their current tax obligations.
If your company sells in multiple states, tools like Numeral can help simplify your compliance efforts. Numeral offers features like automated tax calculations and streamlined reporting. Taking advantage of resources like this saves time and reduces the risk of errors, allowing businesses to focus on their growth and success rather than worrying about compliance.
