Software as a Service (SaaS) companies continue to be the fastest-growing industry segment in the US. They dominate the charts of top companies, from Forbes to the Fortune 500. Yet knowing how to manage Sales Tax can be challenging.
How do I know if my startup is required to collect and remit the sales tax?
The requirement to collect sales tax from our customers and then remit it to the state is determined by whether there is or no ‘Nexus’ between our startup and that state.
Originally, the US Supreme Court defined Nexus as “substantial physical presence” in Quill v. North Dakota in 1992. For example, if my startup was physically located in Florida and I was selling my product to customers in Colorado through Amazon, my startup was only required to collect the tax from its Florida customers and not from its clients living in Colorado.
This was outdated in a global economy dominated by electronic commerce, so 26 years later, in 2018 the original definition of ‘Physica Nexus’ was complemented with the “Economic Nexus”. This establishes that in the event of not having a “substantial physical presence” in the state, the obligation to collect sales tax from our customers is governed by a threshold of the number of sales transactions and/or the total amount of annual sales. Continuing with the previous example, if I sell more than $100,000 from Florida to customers in Colorado, I am required to collect the tax from Florida consumers and Colorado residents, despite my startup not having a physical presence in that state.
Okay, now that we understand the concept of nexus, the next question would be… Are the sales of SaaS taxed?
And the answer is, it depends. Currently, software and digital services are taxed in different ways according to each state:
- SaaS is taxed in 17 states, partially in 2 and in 8 states it is taxed as long as our startup has a server in those states
- Digital movies are exempt in 23 states
- Digital photography is taxed in 27 states
- Digital games are taxed in 26 states
- Software-based training is taxable in 10 states.
- Hardware installation is taxable in 21 states
- Software maintenance is taxed in 24 states and partially in 1.
There are many factors that we need to take into account when determining if my software is taxable or not, such as if it is off-the-shelf or custom software, if the rights for its use are temporary or permanent, places where we have our servers, are we offering packages with our software and other products or services? (If you provide a mix of products and services, break these items out separately on invoices. Grouping taxable and nontaxable items together can subject the entire transaction to sales tax), etc.
To add more difficulty, the rules are constantly being modified by all states, with the sole purpose of collecting more tax.
Steps to comply with my Indirect Taxes.
- Step 1: start accumulating invoicing data on a state-by-state basis and monitor progress relative to the thresholds for each state.
- Step 2: Make sure the sales team has a complete understanding of the sales tax.
- Step 3: Make sure your billing system can calculate the sales tax.
- Step 4: Register your startup in the states in which you expect to cross the threshold of transactions or annual sales amount.
- Step 5: As your sales grow, this manual process is almost impossible. For this, there are digital solutions that will integrate with your billing system and automate the process.
More than 13,000 jurisdictions (states, counties, cities, and special districts) across the United States can request you to collect sales tax from your customers. That is why you have to count on experts to guide you throughout the process, from the beginning to the end. Don’t put your startup at risk!
CFOStartup is your financial, tax, and legal solution. Contact us to find out more about how we can help your startup.