Sales tax laws for SaaS are anything but consistent. While some states treat SaaS like a taxable good, others see it as a service and exempt it entirely—or add conditions that make your head spin.
If you’re selling across state lines, it’s crucial to understand how each state handles SaaS sales tax so you don’t run into any nasty surprises. Here’s a quick breakdown to help you stay compliant.
State-by-State Breakdown of SaaS Sales Tax Requirements
What is SaaS and Why Is Sales Tax For It So Complex?
Software as a Service, or SaaS, is a way of delivering software over the internet.
Instead of installing and maintaining the software yourself, you access it via a web browser. It's become incredibly popular because it's convenient and often more cost-effective than traditional software.
Here's where things get tricky.
The rules for taxing SaaS vary wildly from state to state. Some states tax it, some don't, and others fall somewhere in between. To make matters more complicated, these rules are constantly changing as states try to keep up with the digital economy.
The 2018 US Supreme Court ruling in South Dakota v. Wayfair, Inc. added yet another layer of complexity. This decision allowed states to require out-of-state sellers to collect and remit sales tax, even if they don't have a physical presence in the state. This means you might be on the hook for collecting taxes in states you’ve never set foot in.
It’s complicated but necessary. If you don’t comply with sales tax laws, you could face hefty penalties and back taxes. On a more abstract level, it can impact your brand’s reputation and trust among customers.
Why is SaaS Taxed Differently from Physical Goods?
The difference between sales tax on SaaS products and physical products boils down to the difference between what’s considered “tangible” and what isn’t.
Physical goods—like furniture, books, or electronics—are tangible. You can hold them in your hands, and they’ve always been taxed in most places. Digital services like SaaS, on the other hand, exist in the cloud. They’re harder to define, and for a long time, they weren’t taxed at all.
As the SaaS model grew in popularity, so did states’ interest in generating revenue from it. When governments realized the money spent on recurring digital services was on an upward trajectory, they wanted a slice of the action.
The past few decades have seen monumental advances in tech, and the definition of taxable goods has to constantly evolve to keep up. SaaS is one of the latest advancements to go under the microscope in terms of sales tax.
Some states classify it as a taxable “service” (the clue is in the name), others see it as a “digital good”, and some don’t tax it at all—yet. This hodgepodge of rules makes it challenging for SaaS brands to keep up and stay compliant.
But… What About Digital Goods? Isn’t SaaS a Digital Good?
Digital goods (like music downloads or ebooks) often fall into a gray area like SaaS.
They’re not physical, but you’re still paying to own or access them. Most states have rules for taxing digital goods now, but again those rules vary wildly. Some tax them the same way they tax physical goods. Others only tax them if they’re purchased as part of a subscription.
For SaaS, the confusion gets even deeper. Your product isn’t something people “own”. It’s something they use. That makes it more like renting a service than buying a product. That said, some states lump SaaS into their digital goods tax laws because it’s easier than creating an entirely new category.
What this means for you: you need to understand where your customers are and how those states treat SaaS.
How States Classify SaaS for Tax Purposes
There are three common ways states handle SaaS taxability.
1. Taxable
In some states, SaaS is treated like a tangible good. Even though it’s digital, people still “use” it to perform specific tasks. States like New York and Texas, for example, classify SaaS as a taxable service, meaning you’ll need to collect and remit sales tax for any customers in those states.
2. Non-Taxable
Other states take the view that SaaS is an intangible service, like legal advice or consulting, and therefore exempt from sales tax. States like Florida have historically exempted SaaS from sales tax (at least for now).
3. Conditional
Then there’s the murky middle ground with states that tax a SaaS company if it meets specific conditions. For example, some states might only tax SaaS if the software isn’t custom-developed for the buyer. In other words, off-the-shelf software is taxable, but custom-built software can be exempt.
Other states might tax SaaS subscriptions but exempt temporary licenses.
Examples of SaaS Sales Tax By State
To make things a little clearer, here’s how some states handle SaaS taxability:
- Taxable states. New York and Texas are pretty straightfoward with their sales tax laws. SaaS is taxable, full stop. If you sell to customers there, you’ll need to collect sales tax regardless of how people use your software.
- Non-taxable states. In contrast, Florida and Montana exempt tax entirely.
- Conditional states. California is generally non-taxable, it does have some exceptions for SaaS that’s bundled with tangible deliverables, like hardware.
The biggest challenge with SaaS tax classification is it’s lack of consistency. What’s taxable in one state might not be taxable in another—or it might only be partially taxable depending on how you structure your offering.
The key is to know where your customers are and how those states treat SaaS.
Compliance Challenges for SaaS Companies
As you can see, getting your head around all these different laws and conditions isn’t a walk in the park. Unlike something concrete, such as a physical product, you’re not just dealing with one set of rules across the board.
Here are some of the most common challenges you might face with SaaS sales tax and how they can show up in your business.
Challenge #1: Tracking and Applying the Correct Tax Rates
Sales tax rates vary by state, county, and even city. That means if you have customers in multiple locations (and there’s a good chance you do), you’re responsible for applying the right rate to each transaction.
If that wasn’t enough of a headache, tax rates also change frequently at a local level. One month, a jurisdiction might introduce a new sales tax, and the next it could increase an existing rate.
And then there’s the tricky issue of how not all states agree on whether SaaS is taxable. So, not only do you have to navigate the different laws in different states, but you also have to keep a close eye on what’s happening at a local level.
Challenge #2: Nexus Rules and Remote Sellers
Nexus is a legal term that means your business has enough of a connection to a state so you need to collect and remit sales tax there.
There are two types of nexus:
- Physical nexus. If you have an office, employees, or servers in a state, that’s a physical nexus. For SaaS companies, this can happen even if you only have a single remote employee working in a specific state.
- Economic nexus. Many states now require you to collect sales tax if your revenue or number of transactions in that state crosses a certain threshold. For example, if you bill $100,000 in annual revenue or make 200 sales in a state, you might trigger nexus there, even if you have no physical presence.
If you’re using multiple platforms for billing, tracking where and when you’re hitting these thresholds can be a logistical nightmare. Just remember that once you’ve established nexus, it’s down to you to register, file, and remit taxes in that state.
A note on deregistration and VDAs: if you stop doing business in a state, you should deregister your business there. You might incur unnecessary filing requirements if you leave an account open when you don’t technically have nexus anymore.
Voluntary Disclosure Agreements (VDAs) can help you’ve been operating in a state without collecting tax.
Challenge #3: Exemption Certificate Management
There are certain circumstances where you might be exempt from collecting sales tax. Maybe you sell to other businesses, maybe your client is a nonprofit or a reseller, or maybe they operate in an exempt industry.
While it’s great you don’t need to collect tax for these transactions, they’re not a free pass from compliance.
In these instances, you need to collect and store valid exemption certificates for any customer claiming an exemption. If you don’t and a state audits you, you can be held liable for any tax not collected that should have been.
Managing these certificates can be tedious, especially because, again, each state has its own requirements. And again, if a certificate expires or isn’t filled out as it should be, it’s on you to fix it.
Tools for Managing SaaS Sales Tax Compliance
Managing sales tax by yourself is hard work. Luckily, there are tools available that can take much of the stress away. They can handle the hard parts for you, from calculating tax rates to filing returns.
Here’s an overview of some of the best tools out there and how they can help.
5 Automated SaaS Sales Tax Solutions
1. Numeral
Numeral is designed specifically for ecommerce and SaaS companies, so it’s great at understanding handling the nuances that come with these types of businesses. It offers precise sales tax calculations and compliance support while integrating smoothly with popular recurring billing platforms.
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2. Avalara
Avalara is one of the better-known platforms for automating sales tax compliance. It integrates seamlessly with a ton of SaaS tools, including Stripe and QuickBooks, and keeps on top of the latest tax rules in every jurisdiction.
3. TaxJar
If you’re looking for something simple yet powerful, TaxJar is a good option. It provides automatic tax rate calculations, real-time reporting, and one-click filing all from one central dashboard.
4. Vertex
Vertex is better for businesses with complex tax needs—so, SaaS businesses with a lot of customers in a lot of places. It’s built to handle multi-jurisdiction compliance and comes with advanced analytics so you can get a big-picture view of your tax obligations.
5. Sovos
Sovos goes beyond sales tax and covers everything from VAT to global compliance. It’s particularly useful for SaaS companies that plan to expand internationally, but it can be a little overwhelming and complex if you’re just starting out.
The Benefits of Automating SaaS Sales Tax Compliance
The biggest benefit of using a sales tax tool is peace of mind. These platforms all minimize the risk of human error or the relatively high chance you miss a nexus. This is incredibly important when you’re dealing with thousands of transactions in multiple jurisdictions.
Automation also has huge time saving benefits. Instead of manually calculating your sales tax rates or preparing returns yourself, you can lean on this software to do the heavy lifting.
And finally, most tools offer powerful reporting features that make audits much less stressful. You essentially have all your records organized and accessible in one place.
How to Choose a Sales Tax Compliance Platform
Not all tax tools are created equal and choosing the right one depends on your unique needs. Here are a few things to prioritize.
- Accuracy. Look for a platform that guarantees up-to-date tax rate calculations for every state, county, and city you sell in. Numeral guarantees your sales tax is filed on time or we’ll pay for your penalties and interest charges.
- Ease of integration. SaaS businesses tend to juggle a lot of tools. If you’re using billing platforms like Stripe, QuickBooks, or Recurly, you’ll want a tax solution that connects seamlessly to your existing stack.
- Customization. Quite often, SaaS businesses have unique billing setups, like subscription tiers or usage-based pricing. Your tax tool should be able to adapt easily to your pricing model.
- Compliance support. Some tools also handle filing and remittance as well as calculations and collections. It’s handy to have one tool for all your sales tax needs.
Final Thoughts
We’re under no illusion that sales tax compliance is by far the least exciting part of running a SaaS business, but it’s really important to get right.
Understanding your sales tax obligations can help you avoid hefty penalties, protect your business, and build trust with your customers all at the same time. And, when you’re working with states that are constantly refining their rules around SaaS, what’s true today might not be true next year.
The best way to handle this is to be proactive. Don’t wait for a tax notice to pop up in your inbox or for an audit to highlight glaring gaps in your compliance. Whether it’s tracking nexus rules, applying the right rates, or managing exemption certificates, having a system in place now will save you a ton of headaches later.
It’s overwhelming, we get it. This is precisely why we created Numeral, which was designed to handle the complexity of sales tax compliance for you. So if you’re pulling your hair out trying to figure out what sales tax you need to pay where, consider using a tax compliance solution like Numeral.
