The United States: a thriving market for SaaS businesses that brings with it both joy and headaches for CFOs.
Why? Because of its agonizing sales tax system.
Tax accountants all over the world wince at the very mention of US Sales Tax, and with more and more states charging tax on software – SaaS execs are joining the club.
So, buckle in as we unpack what sales tax in the US actually means for SaaS companies.
Is software taxable in the US?
The first hurdle is understanding if your product or service is taxable in the states you sell into.
You see, different types of software come under different tax treatments. Software is broken down into the following categories:
Software delivered in a physical form (e.g. a disc)
Cloud-based software-as-a-service (SaaS) products
To give you an example, a business selling SaaS into the US, would be liable for sales tax in about 50% of states, where a business selling downloadable applications would be liable in about 80% – not forgetting, of course, that the states charging tax, do so at different rates.
When are businesses liable for sales tax in the US?
So, you know your software is taxable in some states but you don’t have an office there so you're safe for a while, right?
In 2018, a Supreme Court case – Wayfair vs. South Dakota – saw a huge shift in the way software is taxed. Overnight, the interpretation of the law changed to mean that state tax authorities can utilize a concept called “economic nexus”.
As a result, any business selling software to customers in the US can be liable for sales tax, regardless of whether or not the company has a physical presence there.
Unlike other countries, the US does not distinguish between B2B and B2C sales so any business can find themselves liable. Many states do have sales thresholds before tax is due, but these can be as little as one or two hundred transactions, so even small businesses aren’t exempt.
The registration process
Most SaaS businesses will be selling into more than one US state, which makes the amount of research you have to do in order to understand where to register huge.
Once you’ve figured it out, you’ll find that a lot of states still prefer to manage the process on paper – that’s right, by mail 📬.
Once complete, your tax permits will be posted and the majority of further correspondence will arrive by post too.
Our tax experts estimate that a mid-market SaaS company with $5million in ARR would need to register in at least 20 US States. It can take up to five hours to gather the data and complete the registration process for each state – that’s a hundred hours of your time, just to register.
Getting to grips with 11,000 US sales tax jurisdictions
In the US, each state is treated as if it is a separate territory in terms of tax regulations. The means that, unfortunately, there isn’t a flat approach that you can adopt.
Some keep it simple, a single flat rate for all sales and all you have to do when you file is declare your level of sales – easy ✅ .
Others have a state, county, and city tax rate (some even have special tax rates for particular districts or buildings – like a large McDonald’s in Texas). Not forgetting Colorado, where you actually have to register with Denver separately too.
These varying tax rates mean that when you file and remit your taxes, you need to file the right amount for each location in the state. To give you an idea of how painful this can get, Texas alone has 1,700 jurisdictions – not so easy.
Ongoing tax compliance
Once you’re up and running you need to make sure you stay up to date, as the tax authorities might tweak the tax rates – you know, just to keep you on your toes.
These updates might be mailed to you, so it’s best to check the website for each authority to make sure you don’t find out too late.