State & Local Tax Blog

What’s the Deal with Sales Tax on Digital Goods & SaaS?

State laws generally lag behind the latest technology by at least a decade. But now states are starting to wise up to the ways of selling online, and if they haven’t already, developing laws to capture that sales tax on digital goods and SaaS.

Software as a service (SaaS) and digital goods (music, video, eBook downloads, etc.) have changed the way consumers buy products and consume media. They have also changed the way businesses sell to customers across the United States and around the globe.

However, that wide reach has made taxing these products and services difficult for states. Most tax codes were codified based on transactions involving tangible property. Intangibles add complexity in determining “what” is taxable. As a result, many companies, from start-ups to larger tech companies, have gotten used to not having to deal with the complexities of state sales tax.

States can’t tax something that isn’t directly enumerated in the law.

But now states are starting to pick up that slack. Some states already impose sales tax on digital goods and SaaS, and even more are going to be exploring legislation in the next few years.

In this post, we’ll explore what these new laws mean for companies offering SaaS and digital goods. We’ll also explore at a high level the first steps you need to take to be ready to collect and remit state sales tax.

Why Does State Sales Tax on Digital Goods and SaaS Matter?

Even if you’ve never been involved in state sales tax before, you really need to start looking into where you could have liability. If you don’t, the costs for your company can be margin-killing.

Let’s say you sell in all 50 states and DC. Out of those 51 areas, 47 of them impose a sales tax in some form. You could be audited by any one of those states – at any time. If you’re not compliant, then you could be subject to years’ worth of taxes, penalties, and interest.

That kills the margin – even in an industry with a higher margin than most traditional companies. This is why you need to explore where you need to get compliant.

Get Compliant Where You Need to Be

We like to say – “It starts with Nexus.”

But if you’ve never dealt with state sales tax before you may be asking – “What’s Nexus?”

Your nexus is where your business has a responsibility to collect and remit state sales tax. It can be broken down into two types:

  1. Physical Nexus – locations, employees, contractors, inventory, etc.
  2. Economic Nexus – revenue and transactional thresholds set by the various states.

Physical nexus at its core is pretty easy to understand – but there can be some nuances there. However, if you’re a SaaS provider or selling digital goods, you’re probably more concerned with economic nexus. So, let’s explore that.

The Complexities of Economic Nexus

Economic nexus is relatively new. If you’ve not been paying attention to sales tax before, here’s a little history for you.

South Dakota v. Wayfair, Inc. is a 2018 U.S. Supreme Court decision that gives states the right to force out-of-state sellers to collect and remit sales tax, even if they do not have a physical presence in the taxing state.

These laws dictate that sellers are liable for the collection of sales tax if they meet or exceed a state’s economic threshold. Companies reach this threshold if they:

  • Sell a certain amount of personal or electronic property into the state in a given year.
  • Make a certain number of transactions per year in the state.
  • Or in some cases – both.

To put it frankly, it means that your company likely must register in several more states than you would’ve had to just five years ago.

Wayfair and the resulting nationwide economic nexus legislation changed the game for sellers of all types.

So, what can you do about it?

How to Get Compliant with Sales Tax on Digital Goods & SaaS

The simple answer on how to get compliant starts with knowing where you have liability. But that’s easier said than done. You have to go through, state-by-state, and figure out if you meet thresholds that establish nexus, and understand if your products and services are taxable in those states.

From there, you’ll need to register to collect sales tax, pay any owed taxes and configure your ecommerce platform to start collecting taxes. But before you get registered, you should try to take advantage of sales tax refunds, marketplace facilitator laws, and other exemptions that can reduce your total liability.

This is a lot. And we understand why you may not have even thought about sales tax before.

You’ve never had to.

Plus, you’re busy with other important things … like running your business. Sales tax on digital goods and SaaS can be overwhelming for the uninitiated. It’s a lot to take on, and we hear stories all the time about people who start to investigate the process of getting compliant.

Getting compliant is a tough pill to swallow if you’ve never had to deal with it – but the worst thing you can do for your business is ignore it.

Conclusion

State sales tax is a complex subject. It gets even more complex when the products or services involved aren’t traditional products or services. There’s a lot of information out there about where SaaS and digital goods are taxed.

But it really comes down to your unique situation and the context that you sell your digital goods or software. Getting sales tax compliant isn’t a one-size-fits-all solution. That’s why you need to talk to a sales tax expert.

Do you offer digital goods or SaaS and need to get sales tax compliant? We’re here to help. Fill out our short, no-strings-attached What’s Next questionnaire to find out next steps your company can take.

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