Do SaaS Companies Charge Sales Tax?

The question of whether Software as a Service (SaaS) companies must charge sales tax is complex due to varying state laws. SaaS is a digital offering, unlike tangible products, and existing sales tax frameworks were not designed for it. No federal rule governs SaaS sales tax; each state determines its own approach, leading to diverse regulations. Understanding SaaS classification and sales tax triggers is key.

Understanding SaaS Taxability Across States

Taxing SaaS is challenging due to its classification: tangible personal property (taxable) or intangible service (often exempt)? States vary. Some classify SaaS as tangible personal property. New York and Pennsylvania, for instance, consider prewritten computer software, including remotely accessed SaaS, as taxable.

Other states classify SaaS as a service, extending sales tax laws to include it. Texas, for example, considers SaaS a “data processing service,” generally taxable with a partial exemption. Other states do not classify SaaS as taxable, especially if they do not tax services. California and Florida, for instance, often do not tax SaaS, classifying it as a non-taxable service. This creates varied rules where SaaS taxable in one state may be exempt in another.

Factors Determining If SaaS Is Taxable

SaaS taxability depends on factors states consider. The “True Object” test assesses the transaction’s primary purpose: is the customer acquiring the software or the service provided through it? If the goal is to access a service facilitated by the software, it may be treated differently than if the customer gains control or possession.

Delivery method influences taxability. Traditional on-premise software, delivered via physical media, is tangible personal property and taxable. Cloud-based SaaS, delivered remotely, complicates this due to no physical transfer. States distinguish between downloaded software (taxable) and remotely accessed SaaS (some states exempt due to its intangible nature).

Customization levels differentiate tax treatment. Highly customized software, developed for a single client, is a professional service and may be exempt from sales tax. This contrasts with off-the-shelf, prewritten SaaS, which is more frequently taxed. If prewritten software is modified, modifications may be exempt if separately stated on the invoice and considered a custom service.

States differentiate between a software offering and a service utilizing software, like data processing services. Some states tax data processing services (which can include SaaS), while others do not, or have specific exemptions. Bundled transactions, where SaaS is sold alongside other services or products, add complexity. Businesses must separate taxable and non-taxable components on invoices; otherwise, the entire bundled price may become taxable.

Nexus and Sales Tax Obligations

A key consideration for SaaS companies is “nexus,” a sufficient connection between a business and a state that obligates sales tax collection. Without nexus, a company typically has no sales tax collection requirement. Nexus can be triggered in two ways: physical nexus and economic nexus.

Physical nexus is the standard, established when a business has a tangible presence in a state. This includes an office, warehouse, employees, or inventory storage. Even temporary activities like attending trade shows can establish physical nexus. Any such physical activity triggers a sales tax collection obligation.

Economic nexus, a recent development, arose from the 2018 Supreme Court decision in South Dakota v. Wayfair, Inc. This ruling eliminated the physical presence requirement, allowing states to impose sales tax obligations based solely on economic activity. States adopted varying economic nexus thresholds, typically based on sales volume or transaction count, such as $100,000 in gross sales or 200 separate transactions annually. Meeting these thresholds obligates a SaaS company to register for and collect sales tax, even without a physical presence. This increased the compliance burden for national SaaS companies, requiring monitoring sales into numerous states to determine nexus.

Common Exemptions and Specific Scenarios

Even when SaaS is taxable, specific circumstances can lead to exemptions. One common exemption is the resale exemption, which applies when a SaaS provider sells its service to another business for resale or incorporation into its own taxable service. The reseller provides an exemption certificate, relieving the original SaaS provider from collecting sales tax. This ensures sales tax is collected only on the final sale.

Certain customer types are exempt from sales tax, regardless of the product or service. Non-profit organizations, government entities, and educational institutions qualify for sales tax exemptions. SaaS providers selling to these entities must obtain documentation, such as an exemption certificate, to validate tax-exempt status.

Exemptions can also apply based on SaaS use. Some states provide exemptions for SaaS used in manufacturing, research and development, or for internal business operations. The distinction between pure SaaS and data processing services is important; some states tax data processing services, while others exempt or apply different rates. Texas, for instance, classifies SaaS as a data processing service and taxes 80% of the charge, with 20% exempt. Custom software, designed for a particular purchaser, is also exempt from sales tax, treated as a non-taxable service.