Is Your SaaS Subject to Sales Tax? How to Comply

General Principles of SaaS Sales Tax

Sales tax traditionally applies to tangible personal property. The rise of Software as a Service (SaaS), delivered via the internet and accessed through subscription, challenges this model as it doesn’t involve physical goods, complicating state tax authorities’ efforts.

States often struggle to fit SaaS into existing tax categories, leading to varied interpretations. Some states classify SaaS as tangible personal property. Other states tax SaaS as a service, often under “information services,” “data processing services,” or “computer services.” This recognizes its intangible nature but subjects it to sales tax if statutes include such services.

Many states now use a “digital goods” category for electronically delivered products like SaaS, modernizing sales tax laws. Complications also arise with bundled transactions, where SaaS is sold alongside other services or products. In these cases, states often examine the “true object” of the transaction to determine if the primary purpose was to acquire a taxable item or a non-taxable service.

SaaS taxability depends on whether it grants access to software rather than ownership. This access-versus-ownership distinction is a key factor in how states define and tax SaaS, contributing to compliance complexity.

How States Tax SaaS

No federal sales tax exists on SaaS; taxability is determined by individual state and local jurisdictions. As of 2025, many states tax SaaS, while others explicitly exempt it or have ambiguous rules.

Some states explicitly tax SaaS. For example, Arizona, Hawaii, Kentucky, New Mexico, New York, Pennsylvania, Rhode Island, South Carolina, South Dakota, Tennessee, Texas, Utah, and Washington, D.C., classify SaaS as taxable. New York treats SaaS as a taxable sale of tangible personal property. Texas considers SaaS a data processing service, making 80% of the charge taxable.

Other states tax SaaS under broader service categories like “information services” or “computer services.” Connecticut taxes SaaS at a reduced rate for business use. Ohio taxes SaaS for business use but exempts it for personal use.

Some states tax SaaS as a digital good, especially if it’s “canned” or prewritten software. Custom software, designed for a single customer, is often considered a non-taxable professional service.

Several states do not tax SaaS, either through explicit exemption or lack of statutes. California, Colorado, Florida, Illinois, Georgia, and Indiana generally specify cloud-based software is not taxable. Illinois and Georgia define SaaS as a non-taxable service. Varying interpretations and legislative changes make SaaS taxability an evolving area.

Sales Tax Compliance for SaaS Providers

SaaS providers must understand sales tax nexus, which determines where a business must collect sales tax. While physical presence traditionally created nexus, economic nexus is now relevant for SaaS companies. This establishes a tax obligation based on sales volume or transactions within a state, regardless of physical presence. Thresholds vary but commonly involve $100,000 in sales or 200 transactions annually.

Once nexus is established in a taxable state, the provider must register with that state’s tax authority before collecting sales tax. This mandatory step allows legal collection and remittance. The process involves an application. Operating without proper registration can lead to penalties.

Accurately calculating sales tax involves determining the correct rate based on the customer’s location. States use either origin-based (seller’s location) or destination-based (buyer’s location) sourcing rules, with destination-based being more common for interstate sales. Sales tax calculation software can automate this process, ensuring correct rates.

After collecting sales tax, SaaS providers must remit funds to state and local tax authorities. This involves filing regular sales tax returns; frequency depends on the volume collected. Higher collections often mean more frequent filing, such as monthly or quarterly. Accurate records are crucial for compliance and audits.

SaaS providers should be aware of potential sales tax exemptions. Common exemptions include business-to-business (B2B) sales, often requiring a resale certificate. Other exemptions may apply to specific industries or uses. Clearly itemizing taxable and non-taxable elements on invoices is important, especially in bundled transactions.