Is SaaS Taxable in Washington State?
Navigate Washington's tax obligations for SaaS. Learn how the state classifies digital services and applies its specific sourcing rules to determine liability.
Software as a Service (SaaS) is a model where software is licensed on a subscription basis and accessed over the internet. Washington state has a defined approach to taxing the digital economy, which requires businesses serving customers in the state to understand how their products are classified and what tax responsibilities follow.
Washington’s Taxation Framework for Digital Products
Washington law provides a framework for taxing digital goods that directly impacts SaaS providers. The state taxes software based on its classification as a “digital automated service” (DAS). A service qualifies as a DAS if it is automated, computer-driven with minimal human intervention, and delivered electronically. This definition encompasses the SaaS model, where customers access prewritten software hosted on a remote server.
Because SaaS is considered a DAS, its sale is subject to two forms of taxation. The first is the Business and Occupation (B&O) tax, a tax on the gross receipts of the business. The second is the state’s retail sales tax, which is collected from the end-user. This dual-tax structure applies to businesses that have a connection, or nexus, with the state.
Determining Tax Liability for SaaS Sales
Gross income from SaaS sales to Washington customers is subject to the state’s Business and Occupation (B&O) tax under the “Retailing” classification. This tax is calculated on the total revenue generated from sales sourced to the state, without deductions for business expenses.
In addition to the B&O tax, providers must collect and remit retail sales tax on their SaaS offerings. The total sales tax combines the statewide rate of 6.5% with applicable local sales tax rates. The correct rate is determined by the location where the customer receives the benefit of the service, a concept known as sourcing.
Washington’s primary sourcing rule is to attribute the sale to the location where the customer’s benefit is received. If that location cannot be determined, the sale is sourced to where the service was ordered from, or alternatively, to the customer’s billing address. If a customer has users in multiple states, the seller must make a reasonable effort to apportion the income based on the number of users in each state. For example, if a business customer has employees using the software in both Washington and Oregon, the income would be apportioned between the two.
Distinguishing SaaS from Other Digital Services
A distinction exists between SaaS and custom software, which is designed for a single client. In Washington, the creation of custom software is subject to retail sales tax and B&O tax under the “Retailing” classification, just like SaaS. Charges for modifying or customizing prewritten software are also subject to retail sales tax.
It is also necessary to distinguish SaaS from data processing services. A pure data processing service, which involves the electronic manipulation of customer-provided data, may be treated differently for tax purposes depending on the service details. Misclassifying a SaaS product can lead to liabilities for uncollected sales tax and unpaid B&O tax.
Compliance and Registration for Sellers
Businesses without a physical presence in Washington may still be required to register and collect taxes if they meet the state’s economic nexus threshold. An out-of-state business establishes economic nexus if its gross retail sales sourced to Washington, including sales of DAS like SaaS, exceed a specified amount in a calendar year. Once this threshold is met, the business must register with the Washington State Department of Revenue.
To register, a business must provide standard information, such as its legal name and Federal Employer Identification Number (FEIN). The process is completed through the state’s online portal and results in the issuance of a Unified Business Identifier (UBI) number.
The UBI number is used for all state-level reporting, including filing B&O and retail sales tax returns. After registering, businesses must track sales, calculate the correct sales tax based on customer location, and file returns on a monthly, quarterly, or annual basis as determined by the Department of Revenue.