Yes. SaaS (software as a service) is subject to a 6.25% sales tax in Texas. Several related services are also taxable if they are packaged with SaaS offerings. There are, however, several factors that determine the final tax rate. For example, some software and digital services qualify for a 20% tax exemption.
As with many other states, like New York and South Carolina, companies need to collect and remit sales tax in Texas only once they have established nexus in the state. Learning the rules associated with SaaS taxability in Texas will help ensure that you stay in compliance with state and local tax laws.
What does taxability mean for SaaS?
Typically, software as a service is accessed via the internet; it is not downloaded to a user’s device. It is often paid for through a subscription. There are many different types of SaaS products, including everything from marketing tools to employee engagement software.
With SaaS, the customer is effectively renting an app that they can connect to as long as they keep paying a monthly, quarterly, or annual fee.
While other types of digital products and services are also available over the internet, the main difference is in how they are accessed. If the user stops subscribing to SaaS software, they likely won't have access to any of the features until they resubscribe. Since SaaS is a digital good that's available as a subscription service, classifying it under existing tax regulations can be difficult.
While Texas collects taxes on SaaS, not every state does. SaaS taxability varies from state to state, due to states classifying and defining digital services, tangible products, and software licensing in different ways. For example, some states like Georgia tax digital services but don't extend this tax to SaaS solutions.
SaaS taxation rules in Texas
Texas currently taxes SaaS. The state also collects taxes on many digital goods and services. If you sell certain professional services alongside digital products or SaaS solutions, they could also be taxed. However, the Texas code states that 20% of the cost associated with most SaaS products is exempted, which means that 80% of the price is subject to the sales tax. The purpose of this exemption is to promote the growth of the tech industry in Texas.
If your company sells SaaS solutions, you need to know how the state taxes remotely accessible software. As mentioned previously, local sales tax will often apply to SaaS sales, in addition to the state tax. In Texas, B2C (business-to-consumer) and B2B (business-to-business) sales are taxed the same way.
If you sell taxable products in Texas, you'll need to identify whether you have nexus in the state. If you do have nexus, you need to collect and remit taxes on sales there.
There are two types of nexus: physical and economic.
If you have a physical presence in the state, such as inventory in a warehouse, employees, or an office, you likely have physical nexus.
Economic nexus is established in Texas when a business reaches $500,000 in revenue during a 12-month period. This threshold includes the revenue you earn from nontaxable and taxable sales. You must calculate it before any exemptions or deductions are applied.
As mentioned before, 20% of the sales tax is exempted for many digital goods and services. You may be able to claim this exemption if you sell SaaS. Some of your customers may also be exempt from paying sales tax on their purchases. While businesses and institutions must apply for the exemption, Texas doesn't collect sales tax from the following entities:
- Charitable organizations
- Nonprofit HOAs
- Educational institutions
- Religious institutions
- Federal institutions
If a customer doesn't need to pay the sales tax on your SaaS solution, you must verify that before you finalize the transaction.
Texas requires companies to collect sales tax on most other types of digital goods, including:
- Applications
- Movies
- Downloadable music
- Digital books
- Photographs
Example: How local tax rates may apply
To understand the types of services that qualify as SaaS, consider Salesforce, a B2B software company that provides its clients with customer relationship management (CRM) software. They also offer marketing automation, application development, customer service, and analytics.
For example, their Marketing Cloud SaaS solution is a subscription-based service that starts at $1,250 per month. The subscription will remain active only if customers keep paying every month.
If Salesforce has nexus in Texas, they will need to charge a sales tax whenever a non-exempt Texas customer pays for a subscription. Let's say that Salesforce has a customer located in Brewster County, which levies a countywide sales tax rate of 0.5%. Add that to the state tax of 6.25%, and Salesforce will need to charge that customer a 6.75% tax on 80% of the full price of the subscription.
As mentioned above, sales tax rates in Texas vary from county to county. In certain locations, consumers and businesses don't need to pay a local sales tax. The statewide tax rate will still apply. The average combined tax rate is 8.20%, including state and local taxes.
Navigating compliance
If you meet the economic or physical nexus threshold in Texas, you must accurately calculate, collect, and remit taxes to avoid penalties. When you fail to properly report and pay the sales taxes that you owe, a 5% penalty will be assessed as long as you pay within 30 days following the due date. If you miss this deadline, the penalty will increase to 10% of the total amount of outstanding taxes.
To maintain compliance with SaaS sales tax regulations in Texas, you must first obtain a sales tax permit. After receiving the permit, make sure you collect the right amount of sales tax based on the county the purchase is made from.
Depending on the amount of money you make, you'll need to file a periodic sales tax return monthly, quarterly, or annually. If you file monthly, your return must be filed by the 20th of each month.
When filing annually, you must pay on January 20. Make sure you report the taxable sales and total sales. To remit the sales taxes you collect, make a payment alongside each tax return. If you don't make the payment on time, penalties will accrue.
If you owe sales tax but haven't collected it from your customers, you might be able to qualify for the Voluntary Disclosure Program, or VDA. Your business can qualify for this program only if it hasn't received a notice of an audit or communication from the Texas Comptroller about the outstanding taxes.
If you no longer want to collect and pay sales taxes in Texas, you can withdraw your business from the state. The Texas Comptroller provides an online form that you can fill out. If you continue to sell SaaS products in the state after you effectively withdraw, you'll need to collect and report taxes.
It can be challenging to keep track of all the laws and regulations associated with sales tax in the U.S. Consider using Numeral to effectively navigate complex tax regulation. This tool will help you maintain tax compliance by automating remittances and monitoring your sales 24/7.
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Additional resources for staying compliant
To learn more about the latest tax rulings and rates in Texas, use the Comptroller's website. This site serves as a hub for all notable changes to the tax code.
If you need further assistance with understanding sales tax and the laws your business must adhere to, the Texas Comptroller also hosts numerous seminars, webinars, videos, and podcasts about popular tax topics to help educate taxpayers.
The bottom line
All SaaS solutions are taxed in Texas. While you may not need to tax 100% of the sale, Texas still has some of the highest rates in the country when you factor in local taxes. If you have nexus in the state and provide customers there with SaaS software, you must stay compliant by regularly reporting tax returns and paying your taxes on time.
Regularly consult the state Comptroller's website to see if there are any updates to the tax code that you should be aware of. And if you're seeking efficiency in your collection of sales tax, consider using tax management software like Numeral.
