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SaaS Tax Exemptions: A Complyt State and Local Tax Guide

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Just as choosing the right stack of cybersecurity solutions is crucial to safeguarding sensitive data and upholding the integrity of your SaaS platform, finding the right tool to automate your sales tax applicability and exemptions is vital to maintaining compliance and mitigating the risk of potential liabilities. 

 

Both technologies require a deep understanding of complex regulations and the need to mitigate risk in diverse terrains across various jurisdictions. 

 

This complexity is why a proactive and comprehensive approach to sales tax compliance is essential for SaaS companies to protect against financial risks and legal issues and ensure operational security and stability.

What is SaaS sales tax compliance?

Sales tax compliance is essential to safeguard the operating security of SaaS. It involves registering for sales tax licenses, collecting sales tax from customers in applicable jurisdictions, filing sales tax returns, and remitting sales tax to the appropriate authorities. Non-compliance with sales tax regulations can lead to penalties, accrue interest charges, and even trigger legal action.

 

Read more: What is SaaS sales tax?

What are SaaS sales tax exemptions?

Some states exclude SaaS from sales tax, while others tax it as a service or tangible personal property. Determining whether your SaaS product is taxable in each state and whether any exemptions apply is crucial. 

 

Here are two reasons why that’s harder than it sounds:

1. Variability of taxation across states

About 20 states impose taxes on SaaS, each with unique rules and definitions. This variability can be challenging for rapidly expanding SaaS companies, as they might inadvertently establish a tax nexus in new states, leading to unexpected tax liabilities. More on this later. 

2. Inconsistent classification of SaaS

The classification of SaaS varies by state. States are increasingly amending their statutes to treat SaaS as tangible personal property, subjecting it to sales tax. In contrast, others classify it as a service, which may have different tax implications. 

 

This change adds another layer of complexity, as states like New York aggressively subject cloud-based offerings to sales tax, whereas others like California do not​​.

 

This inconsistency for SaaS businesses operating across multiple jurisdictions increases the risk of falling foul of the taxman – since it requires staying compliant with the tax laws in each state where they have a presence. 

 

Read more: Should your SaaS collect sales tax?

States offering sales tax exemptions for SaaS

Over 25 states offer sales tax exemptions for SaaS, including Arizona, California, Connecticut, Hawaii, New York, and Texas. 

 

  • Arkansas: SaaS is exempt from sales tax in Arkansas.
  • Florida: SaaS is exempt from sales tax in Florida.
  • Georgia: SaaS is exempt from sales tax in Georgia.
  • Idaho: SaaS is exempt from sales tax in Idaho.
  • Illinois: SaaS is exempt from sales tax in Illinois.
  • Indiana: SaaS is exempt from sales tax in Indiana.
  • Kansas: SaaS is exempt from sales tax in Kansas.
  • Kentucky: SaaS is exempt from sales tax in Kentucky.
  • Maine: SaaS is exempt from sales tax in Maine.
  • Maryland: SaaS is exempt from sales tax in Maryland.
  • Michigan: SaaS is exempt from sales tax in Michigan.
  • Minnesota: SaaS is exempt from sales tax in Minnesota.
  • Missouri: SaaS is exempt from sales tax in Missouri.
  • Nebraska: SaaS is exempt from sales tax in Nebraska.
  • Nevada: SaaS is exempt from sales tax in Nevada.
  • New Jersey: SaaS is exempt from sales tax in New Jersey.
  • North Carolina: SaaS is exempt from sales tax in North Carolina.
  • North Dakota: SaaS is exempt from sales tax in North Dakota.
  • Oklahoma: SaaS is exempt from sales tax in Oklahoma.
  • South Carolina: SaaS is exempt from sales tax in South Carolina.
  • South Dakota: SaaS is exempt from sales tax in South Dakota.
  • Tennessee: SaaS is exempt from sales tax in Tennessee.
  • Vermont: SaaS is exempt from sales tax in Vermont.
  • Virginia: SaaS is exempt from sales tax in Virginia.
  • Washington: SaaS is exempt from sales tax in Washington.
  • West Virginia: SaaS is exempt from sales tax in West Virginia.
  • Wisconsin: SaaS is exempt from sales tax in Wisconsin.
  • Wyoming: SaaS is exempt from sales tax in Wyoming.

 

In California, SaaS is generally taxable, but there are exemptions for certain types of SaaS, such as online advertising and data processing services.

 

In Connecticut, SaaS is exempt from sales tax if it meets specific criteria, such as being delivered electronically and not being customized for a particular customer. 

 

In Hawaii, SaaS is exempt from sales tax if it meets specific criteria, such as being delivered electronically and not being customized for a particular customer. 

 

In New York, SaaS is generally taxable, but there are exemptions for certain types of SaaS, such as online advertising and data processing services. 

 

In Texas, SaaS is generally taxable, but there are exemptions for certain types of SaaS, such as online advertising and data processing services.

Please note that the sales tax laws in each state can change frequently, so it is always best to consult with a tax professional to get the most up-to-date information. (Or else Complyt can take care of that for you.)

Which states charge sales tax on SaaS? 

Approximately 20 states currently tax SaaS, each with its rules and definitions. This variability means that SaaS companies, particularly those expanding rapidly, might unknowingly extend their nexus footprint into these states, triggering tax liabilities​​.

 

The taxation of SaaS services varies across different states and jurisdictions. Some states consider SaaS a tangible personal property, while others consider it a service. This inconsistency creates challenges for SaaS businesses operating in multiple jurisdictions.

 

Here is the SaaS sales tax by state:

  • Arizona: It implements a transaction privilege tax (TPT), which operates like a sales tax and taxes SaaS and most digital products and services. The TPT rate in Arizona varies depending on the city and county where the sale occurs
  • District of Columbia: SaaS and other digital products are generally taxable here and thus subject to the District’s 6% sales tax rate
  • Hawaii: SaaS and other digital goods and services are broadly taxed at a statewide rate of 4% – local tax rates vary and can be layered on top of this base rate, depending on the location of a specific transaction
  • Iowa: Sales tax applies to computer software regardless of its delivery or access method, whether in physical form (as tangible personal property) or provided electronically (as specified digital products). Also, the sales tax rate varies depending on the location of the transaction
  • New Mexico: SaaS is subject to gross receipts tax, similar to a sales tax. The gross receipts tax rate varies depending on the location of the transaction
  • Ohio: SaaS is subject to the state sales tax, currently 5.75%
  • South Dakota: SaaS is subject to the state sales tax, now 4.5%
  • Texas: SaaS is generally taxable in The Lone Star State, but certain types of SaaS are exempt, such as online advertising and data processing services
  • Washington: SaaS is subject to state sales tax, currently 6%

The impact of SaaS sales tax nexus 

Nexus refers to the relationship a business establishes with a state, defining its tax obligations there and requiring it to collect and remit sales tax. For SaaS, nexus can be established through various factors, including physical presence, economic activity, and affiliate relationships.

 

There are some benefits to SaaS sales tax nexus. For example, it has helped to simplify sales tax compliance for many businesses. It has also helped to level the playing field between SaaS and traditional businesses by requiring both companies to collect sales tax.

 

However, with its cloud-based offerings delivered electronically, often without in-state presence, the impact of SaaS sales tax nexus has been tough on SaaS start-ups and small businesses. 

 

As you’ll see, nexus can impact growth and their ability to compete with larger SaaS companies with deeper pockets.

Increased cost of compliance

SaaS must now register for sales tax licenses in multiple states, collect sales tax from customers in those states, and file sales tax returns. This can be a heavy administrative burden, especially for small businesses. 

Pressured to change to regressive pricing models

Some SaaS businesses have had to raise prices or reduce their margins to cover the cost of sales tax compliance, making it harder to compete with companies not required to collect sales tax. 

Greater risk of penalties and interest

SaaS businesses are exposed to fines and audits, which can become a money pit, especially for companies struggling to make it in an ultra-competitive market.

The costs of tax expertise

As new sales tax regulations emerge and change, the need for specialized tax knowledge becomes increasingly critical. SaaS businesses may need to hire tax professionals to help them comply, which is money that could have been invested in improving product and revenue.

Remote Work Models and Nexus Determination

Remote work models complicate the determination of nexus and sales tax obligations. If a SaaS company has employees in states different from its headquarters, this creates a nexus irrespective of its sales volume, impacting total tax liability​​. Noncompliance can lead to cumulative liabilities and material exposures.

 

Also, sales tax exposure is a significant factor in mergers and acquisitions, where due diligence is crucial given the short lifecycle of most technology companies​​.

 

The Future of SaaS Taxation

SaaS’s “move fast and break things” culture can lead to sales tax oversight, making sales tax compliance as paramount as your cybersecurity measures. 

 

Understanding tax terms, regulations, and practices is crucial for positioning SaaS companies to succeed in handling taxes properly, especially since states are becoming increasingly aggressive in enforcing sales tax nexus rules. This means that even if they do not have a physical presence in a state, more SaaS businesses will be required to collect and remit sales tax. 

 

Some states are also increasing their use of sales tax audits, meaning your SaaS company should be prepared and have ironclad processes to ensure you comply with all sales tax laws.

 

Your company should also be locked into the constantly changing sales tax rates and exemptions to ensure you collect the correct sales tax amount.

+100 SaaS companies stay compliant with Complyt 

SaaS companies can mitigate the risks of penalties, interest charges, and legal action by implementing automated sales tax solutions like Complyt to uncomplicate compliance efforts and reduce the risk of errors.

 

Complyt simplifies SaaS sales tax compliance by monitoring and registering, calculating sales tax, automating filing and remitting, and keeping detailed records. 

All on one intuitive yet powerful dashboard.

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