Is Software Taxable in Massachusetts?

In Massachusetts, the taxability of software depends on its nature, delivery method, and use, as defined by the Department of Revenue (DOR). The tax treatment can vary based on product classification and contracts. In late 2024, the DOR released a working draft of a new regulation to update existing rules for modern business practices.

The Core Distinction Canned vs Custom Software

The foundation of software taxation in Massachusetts is the distinction between “canned” and “custom” software. Canned software, also called prewritten software, is a program designed for general use and sold “off-the-shelf,” such as office suites or antivirus programs. Massachusetts treats prewritten software as tangible personal property, making its sale subject to the state’s 6.25% sales tax.

This tax obligation applies regardless of how the software is delivered. Whether a customer buys a physical CD-ROM, downloads the program, or receives it via a temporary “load and leave” transfer, the transaction is taxable. The primary factor is the prewritten nature of the software, not the medium of transfer.

In contrast, custom software is considered a nontaxable professional service. It is defined as a program specifically created or developed for a single client to their unique specifications. The transaction is viewed as the provision of a programmer’s professional service rather than the sale of a pre-made product.

Tax Treatment of Cloud Computing and SaaS

The taxation of cloud computing and Software as a Service (SaaS) follows the rules for prewritten software. Massachusetts considers the sale of a license or the right to use software on a remote server to be a taxable transfer. Therefore, subscription fees for SaaS products, such as a project management tool accessed through a web browser, are also taxable.

The primary factor is the customer’s right to use the software, not physical possession. This approach means that whether a program is downloaded or used via the cloud, the tax treatment is the same if the software is prewritten. Proposed regulations also seek to establish new requirements for apportioning sales tax on software used in multiple states.

When a transaction bundles a taxable SaaS subscription with nontaxable services, the structure of the sale determines the tax outcome. Under proposed rules, the software is not taxed if its charge is not separately stated and its value does not exceed 10% of the total transaction price. If these conditions are not met, the software portion of the sale must be taxed.

Taxation of Related Services and Agreements

The taxability of services sold with software depends on how they are billed. If an installation charge is a required part of a taxable software sale and is not separately stated on the invoice, the fee is also taxed. Conversely, if the installation service is optional and its price is stated separately, the service charge is not taxable.

Training services are considered nontaxable professional services. As long as the fees for training are itemized separately from the price of any taxable software, they are exempt from sales tax.

Maintenance agreements present a more complex scenario. A contract that only provides support services, such as technical assistance via a help desk, is not taxable. However, if the agreement includes future software updates or upgrades, it is considered a sale of prewritten software and becomes taxable.

While existing regulations apply a default rule that subjects 50% of a bundled contract to tax, a proposed replacement regulation aims to eliminate this. The new framework would instead analyze whether the software element is an inconsequential part of the overall service transaction to determine taxability.

Specific Scenarios and Exemptions

When a vendor takes a prewritten program and makes custom modifications for a specific client, the tax treatment is split. The portion of the sales price for the original, prewritten software remains taxable. The charges for the custom modification services, however, are not taxable, provided they are separately stated on the invoice.

Massachusetts law also provides sales tax exemptions for software used in specific business activities. One exemption applies to software purchased by a qualifying manufacturing or research and development (R&D) corporation. To qualify, the software must be used directly and exclusively in the manufacturing process or in R&D.

To claim these exemptions, the purchaser must provide the vendor with a completed Form ST-12, an Exempt Use Certificate, at the time of the transaction. This form is also used to apportion tax when software is purchased for use in multiple jurisdictions. This documentation is needed for the vendor to prove that the sale was exempt from tax.