If you are a CFO at a business that provides SaaS to clients in multiple states, new state sales tax rules will have an impact on your tax reporting and compliance obligations

A recent Supreme Court case and related law changes in many states have resulted in significant new state sales tax obligations on many SaaS providers. It’s important to understand that these changes could result in new tax collection responsibilities on your business even in states where you have operated without them in the past.

Executives need to act quickly to make sure that their existing operations are in compliance with the new rules and that their systems can adapt as sales growth and law changes trigger additional obligations.  

Two Sales Tax Changes That SaaS Providers Need to Consider

Historically, most states have not imposed their sales tax on payments for services. As a result, SaaS providers were not required to collect and remit sales taxes on transactions in those states.  In the 16 states that did impose sales tax requirements on cloud-based services, many SaaS providers were still exempt from the obligations because they did not have a physical connection to the jurisdiction, like an office or a server farm. “Physical presence” was the standard used by the Supreme Court to determine if a business established “nexus” in a state. (Nexus is the level of presence that allows a state to tax an out-of-state entity without violating the Constitution’s Commerce Clause.)

These circumstances started to change on June 21, 2018 when the Supreme Court ruled in South Dakota v. Wayfair, Inc. (Wayfair) that economic activity within a state could also establish nexus.

The ruling determined that a sales tax obligation could be established in some circumstances solely through virtual contacts with a state. Most states have since established some variation of an economic nexus standard.  The most common variation requires a company to collect and remit sales tax if it has more than $100,000 in sales to the state, or 200 or more transactions delivered into the state during the preceding or current calendar year.

What Wayfair Means for SaaS Providers Now

These changes mean that SaaS providers may now be required to collect and remit sales taxes in states where they have operated for years without any obligation.

If your business crosses the economic nexus threshold in a state that imposes sales tax on services, you will need to bill your clients for those amounts and remit them to the state. In fact, you’ll need to start tracking your transactions in the state from the outset in order to know when you cross a threshold that triggers a sales tax obligation. Subscriptions models increase the likelihood that you could become liable, as a monthly billing cycle would generate twelve transactions per year for each client.

What SaaS Providers Can Expect In the Near Future

We noted above that several states already tax the sale of digital products delivered electronically to their residents. As states evaluate their sales tax laws considering this latest change, it seems likely that many more states will introduce legislation extending their laws into the digital goods sector.

For example, sales of digital products were exempt from sales tax in Iowa until January 1, 2019.  Now Iowa taxes electronically transferred digital products such as digital books and audio-visual works. Also, the District of Columbia has recently passed emergency legislation to amend the sales and use tax treatment of digital goods sold or used in the District. Effective January 1, 2019, the definition of “retail sale” in the D.C. Code has been expanded to include charges for or the sale of digital goods, such as digital audio-visual works, digital audio works, digital books, digital codes, digital applications and games, and other taxable tangible personal property delivered electronically.

In addition to digital goods, more states are likely to start taxing SaaS and similar cloud-computing services. For example, effective October 1, 2018, Rhode Island made the sale, storage, and use of vendor-hosted prewritten computer software subject to sales tax, and as of January 1, 2019, SaaS is subject to sales tax in Iowa, but an exemption applies for the sales price of SaaS provided to a business for its exclusive use. 

Sales Tax Compliance Strategy for SaaS Providers

Given the Supreme Court’s expansion of nexus to include economic activity, any of the states that expand their sales tax rules to include digital goods and SaaS will easily be able to apply the new requirements to out-of-state businesses. SaaS providers need a sales tax compliance strategy that analyzes where they currently have collection obligations as well as where they are likely to incur them as business grows and laws change.

SaaS and digital goods providers should be working closely with knowledgeable state and local tax advisors to track the obligations created by electronic sales and law changes and ensure proper sales tax collection and compliance.

To learn more about how the SALT experts at Freed Maxick can help your SaaS business manage sales tax obligations across multiple states during this period of significant change, please contact connect with us by clicking on the button or call us at 716-847-2651 to discuss how we can help guide your business through the aftermaths of the Wayfair sales tax case decision.