Taxability of SaaS: Are States Keeping Up With the Way We Do Business?

and   |   March 31, 2022

Sales and Use Tax & Software as a Service (SaaS)

As businesses continue to develop new ways to serve customers, thanks in large part to new technologies, State laws have had trouble keeping up. This is especially true when it comes to software and services delivered via the internet – commonly known as SaaS, or Software as a Service. States have been slow to change what is subject to sales and use tax in their respective jurisdictions. If this trend continues, States will be leaving cash on the table and many businesses will need to carefully monitor each state’s laws to determine if SaaS is subject to sales and use taxes in the states in which they are doing business or will be doing business.


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The Sales and Use Tax Landscape

While the Wayfair decision in June 2018 certainly changed the sales and use tax landscape in terms of nexus  ̶̶  lowering the nexus threshold from strictly a physical to an economic presence  ̶̶  it still did not close the gap between State laws and new ways of doing business. Wayfair effectively expanded the pool of taxpayers subject to sales and use tax collection and remittance, which was a monumental shift, but it happened nearly 20 years after Amazon started selling more than just books.

The taxability of SaaS is one example of the snail’s pace at which States move to adapt their laws to changing business practices. Salesforce launched its CRM platform in 1999, which is generally regarded as the birth of SaaS. Yet, 23 years later, less than half of states with a sales tax subject SaaS to tax. While SaaS may take various forms, inaction on the part of some states could indicate either a lack of awareness on the part of Departments of Revenue (DORs) or a reluctance to expand existing regulations. Some states, such as Maryland and Connecticut, have legislated the tax treatment of SaaS, proving it is not impossible or taboo to do so.

Some of the challenges States face in keeping up with technological advances like SaaS include:

  1. Defining Software as a Service – Not all states are able to determine if SaaS is the sale of taxable software or a service. State legislation notoriously lags behind technological developments in their understanding and subsequent treatment of those same advancements. For example, with Senate Bill 257, Indiana temporarily exempted SaaS transactions that were previously treated as taxable, beginning June 30, 2018 and ending July 1, 2024. However, this temporary measure has not resolved the state’s issue with defining and taxing SaaS, leaving the consumer vulnerable to any subsequent revisions the state may make in their treatment.
  2. Evolution of SaaS – Software as Service has been described as an adolescent in the midst of growing pains. As SaaS products continue to evolve, they may enter additional areas lacking statutory guidance. As such, states may be reluctant to define the taxability of rapidly changing technologies too soon.
  3. Sales Sourcing – As with other services, the location where a service is billed versus where it is used may not always be the same. With SaaS, as long as the consumer has an electronic device, such as a smartphone or tablet, the software may be accessed from anywhere. User location may not be information that is normally collected by the hosting vendor. In light of the 2018 Wayfair decision, states must decide how to capture sales related to SaaS to determine when and where economic and transactional thresholds have been met.
  4. Letter Rulings – These rulings, although specific to a taxpayer and its transactions, are being used by taxpayers to define a state’s stance on SaaS. These rulings are not law; however, the guidance allows states to sidestep or delay needed legislation to codify their treatment of SaaS.
  5. DOR Resources – States have limited resources. While revenue collections may swing one way or another, ultimately what the DORs have available to spend will factor into their ability to stay on top of current developments.

Addressing the Taxability of SaaS

Eventually states will enact laws, or amend existing ones, to address SaaS. The question remains whether it will come in time to truly have an impact. In any event, businesses should still monitor state tax laws in the states in which they are doing business to avoid creating sales and use tax exposure in such state.

If you sell a SaaS product, consider contacting the REDW State and Local Tax team to make sure you stay compliant with state tax laws and rules. We welcome your questions.

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