With Software as a Service (SaaS) emerging as the preferred method of delivery for software, the issues surrounding taxation of this leading edge technology are becoming more complex. Gray, Gray & Gray has the experience and resources necessary to assist SaaS developers and providers in navigating multiple tax jurisdictions and changes in revenue recognition rules helping you build an advantageous tax strategy while complying with federal, state, local, and foreign tax authorities.
Software can be placed into one of three categories: tangible software, downloaded software, and software accessed via the cloud. Tangible software is a product sold to a customer, either in a retail setting or ordered online and delivered, such as software delivered on a CD. Downloaded software refers to a software license that allows a customer to download a program directly to their local hard drive. Software accessed via the cloud is the newest classification and includes SaaS products which a customer accesses over an Internet connection.
Compliance with State Sales Tax
Delivery of SaaS services are generally taxed on the state level, but not by all states – yet. The SaaS model of delivery has many state tax authorities rushing to bring their tax code and tax collection methods up to speed. Currently, 17 states and the District of Columbia apply sales tax to SaaS products, but as use of SaaS becomes increasingly widespread we expect that more and more states will move to tax it.
All but five states apply a sales tax to most transactions that involve tangible physical property. Because SaaS is a digital transaction – no tangible physical property changes hands – most of these states find themselves unable to tax the transaction. Other states consider SaaS to be “canned” software, which is defined as software solutions that cannot be modified or altered beyond their original functionalities. This makes it tangible property and taxable. Still other states apply sales tax to certain services, and in these states SaaS generally is taxable under that definition.
Thanks to the 2018 Wayfair decision by the U.S. Supreme Court, you may be required to collect sales tax and remit the taxes collected for states in which SaaS is taxed. If this is the case, you must register for a sales tax permit in the states in which you have clients using your SaaS product. It is necessary to register before you start to collect sales tax. At this time the state will notify you of its sales tax reporting and filing requirements, including frequency and deadlines. These will vary from state-to-state.
Next, you start to collect sales tax. Again, the process varies by state. Some states require you to charge the sales tax rate at the point of origin (your location), while others require you to charge sales tax at the rate in effect at the client’s location. In almost every case you will need to add sales tax to each transaction, whether it is a monthly, quarterly, or annual SaaS fee. You will need to file a report with each nexus state on how much sales tax you collected, and remit the appropriate amount, usually through an electronic transfer of funds. Some states require more detailed reporting, including the city or county in which the sales tax was applied.
SaaS knows no borders. Sales to overseas users can bring their own tax and accounting requirements. Because we have close connections with a network of foreign accounting offices, we can help you determine which jurisdictions will tax SaaS, and how to navigate the compliance and reporting issues that go along with export sales.