You’re busy building a beloved SaaS product and growing your ARR. The last thing you need is to be derailed by worrying whether or not you’re handling sales tax correctly.
This post will go over the basics of sales tax for SaaS businesses and show you how to get started automating the unprofitable yet vital task of sales tax compliance.
What is sales tax?
It pays to start with the basics. In the US, sales tax is governed at the state level and forty-six US states (and DC) have a sales tax.
Sales tax is a percentage of a sale that businesses are required to collect at the point of sale and then periodically remit to the state. Since sales tax is used to pay for budget items like schools, roads, and public safety, states are quite invested in ensuring they receive all the sales tax they are owed by law.
States get to set their own sales tax rates and define what products (and services) are taxable.
Next comes the big question:
Is your SaaS company required to collect sales tax?
The answer here, as with most things sales tax related, is “it depends.”
Businesses are required to collect sales tax from buyers in states when they meet two conditions:
- The business has sales tax nexus in the state
- The product or service the business is selling is taxable in that state
Let’s break that down.
Does your SaaS business sales tax nexus?
“Nexus” is just a fancy way of saying that you have a physical connection to a state.
Conditions that create nexus include:
- Having a physical location in a state (this includes home offices)
- Having an employee, contractor, salesperson or other personnel in a state
- Having an affiliate in a state
- Temporarily doing business in a state such as making sales at a tradeshow
- Having a significant economic presence in a state
For example, a business will always have sales tax nexus in the state where it’s headquartered. However, you’re only required to collect sales tax if you both have nexus in a state and meet the second condition:
Is your SaaS product taxable?
This is where sales tax liability gets tricky. Each state makes their own rules and laws on how they tax SaaS. Some states, like Washington, consider SaaS a software and tax it as if it were a tangible product, meaning that your business is required to collect sales tax from your customers. Others, like California, consider SaaS a non-taxable service.
For the purposes of this post, we’re talking about SaaS products as cloud-based services, most often B2B, that are not sold as physical products or stored on a customer’s computer or network. Does that sound like your SaaS business? Then we have a list of states where SaaS is and is not taxable right here.
However, some states get nitpicky. For example, if you include a tangible item like a flash drive with your service, that item – or the entire service – may become taxable where it would not have been taxable before.
Also, a handful of states only consider SaaS taxable if it’s used for business purposes and not for personal use (or vice versa. States are weird.)
Not sure when you’re required to collect sales tax? TaxJar has your back. We’ll help you determine where you’re required to collect sales tax so you never have to worry about sales tax compliance. To learn more about TaxJar and get started, visit TaxJar.com/how-it-works.
Are you collecting the right sales tax rate?
Remember how every state gets to make their own sales tax laws and set their own rates? This is another tricky aspect of sales tax for SaaS businesses.
If this were 1955 and you were selling waffle irons at a brick and mortar store, you’d only be required to collect the single sales tax rate at your store’s location. But sales tax is charged at the point of sale. And in this case, the point of sale is your customers’ homes and offices or wherever they set their billing address.
Further, sales tax is made up for multiple rates. There may be a state rate, plus a county rate, plus a city rate, plus a special taxing district. This is why if you go shopping in your hometown and then go shopping in the next town over you may notice that you pay a different sales tax rate for each purchase.
Combine those two factors, and it can be difficult to charge the rate sales tax rate from each customer. If you overcharge sales tax, your customer isn’t going to be happy. But if you undercharge, you’ll end up owing the difference to the state out of your own profits.
That’s where TaxJar comes in. The TaxJar API ensures that you charge the right amount of sales tax from the right customer, every single time.
Sell via a service like Chargebee or use an ERP? TaxJar also ensures that you’re collecting and reporting the right amount of sales tax to the states. We directly integrate with multiple sales channels and ERPs so that every single aspect of your business’s sales tax solution is automated and out of mind.
Are you wasting time reporting and filing sales tax?
Sales tax is not a profit center. You charge sales tax to your customers and then periodically pass it on to the state’s taxing authority.
So you don’t need to be spending your valuable time on sales tax.
TaxJar AutoFile gathers your sales tax data from all your sales channels and files your sales tax returns automatically. We’ll even remit what you owe to the state. So you can spend your time on other things, like building your runway or maybe taking a day off once in a while.
TaxJar is here to help you mitigate sales tax risks and take the daily hassles of sales tax compliance off your plate. To learn more about TaxJar and get started, visit TaxJar.com/industry/saas.
Other SaaS Resources
And check out why Basecamp trusts TaxJar with their sales tax compliance: