2022 SaaS Tax: State-by-State Details
The way states tax software as a service, more commonly referred to as SaaS, is an ever-moving target. Here’s what accountants need to know to counsel clients effectively in 2022.
There are currently 16,000 software-as-a-service (SaaS) companies in the US. These companies sell their products, typically on a subscription basis, into states nationwide. But are they paying attention to where their sales are triggering nexus? Do they even know where SaaS is taxed?
If they don’t, it’s not entirely their fault. SUT legislation is complicated, and software tax is no exception. Today, we’ll get you up to speed on what’s happening with SaaS tax across the US, arming you with all the information you need to advise clients effectively in 2022.
Before we deep dive into SaaS tax details, let’s talk about how software is taxed as a whole.
Current Software Tax Legislation
As is the case with all sales and use tax, states can develop their own rules and regulations around how to tax digital goods, including software.
The primary considerations that determine how software is taxed include:
- Where the software is canned (one-size-fits-all) or custom
- Whether the delivery is digital (download) or physical (disk)
- Whether the software stands alone or is bundled with services
- What purpose the software serves; (whether it’s for business or personal use)
- Where the seller and end-user are located
- Whether the software is accessed via a cloud-based server
That last bullet point is where SaaS fits into the equation. It’s important to know that sometimes, multiple considerations listed above come into play when determining whether a specific software category or use case is taxable.
Software as a service (SaaS) is a form of cloud computing where the software is hosted by a third-party provider and delivered to customers as a service via the internet. In simpler terms, SaaS products are hosted in ‘the cloud,’ meaning they have no physical or tangible presence.
States that tax SaaS typically categorize it in one of two ways:
1. As tangible personal property
2. As a data processing or communication service, which is taxable in some states
Which States Tax SaaS
These 20 states currently tax SaaS [updated in March 2022]:
Alabama (Admin. Code r.810-6-1-.37)
Arizona (LR 04-010)
Connecticut (Reg. §12-426-27(b))
District of Columbia (Taxation of Digital Goods)
Hawaii (Rev. Stat. §237-13)
Iowa (S.F. 2417; taxation on digital products)
Maryland (Business Tax Tip #29; Sales of Digital Product - page 16)
Massachusetts (Regs. Code tit. 830, §64H.1.3)
New Mexico (Admin. Code tit. 3, §188.8.131.52)
New York (TB-ST-128)
Ohio (Rev. Code Ann. §5739.01)
Pennsylvania (Letter Ruling SUT-12-001)
Rhode Island (Gen. Laws §44-18-7)
South Carolina (Code Regs. Ann. 117-329.4, Revenue Ruling #03-5)
South Dakota (Admin. R. 64:06:02:78)
Tennessee (Code Ann. §67-6-231)
Texas (Admin. Code §3.330)
Utah (Private Letter Ruling, Opinion No. 09-003)
Washington (Rev. Code §82.04.050)
West Virginia (Taxability Matrix)
The link next to each state directs you to government-provided information on the taxation of SaaS in that jurisdiction.
Standout Legislation in States with Sales Tax
While all of the states above tax SaaS, taxation rules aren’t all cut and dry. Here are a few examples of how states enforce unique tax treatment for software-as-a-service.
▪️ Connecticut has different SaaS tax rates, depending on whether the software is for personal or business use. “As of October 1, 2019, electronically accessed or transferred canned or prewritten software will also be taxable at the 6.35% rate, except for sales of such software to a business for use by the business, which will remain taxable at the 1% rate for computer and data processing services.”
▪️ Hawaii technically doesn’t have a state tax but does apply a general excise tax (GET) to every good and service not overtly defined as tax-exempt. Here’s how it works.
▪️ Idaho only taxes certain software types and delivery methods, as defined on this chart.
▪️ Ohio only requires businesses to pay tax for SaaS products; personal users are exempt.
▪️ Pennsylvania legislation says SaaS is not taxable if the user is located outside the state.
▪️ South Carolina deems a “charge to access a website” taxable as a communications service.
▪️ Tennessee defines the use of computer software that “remains in possession of the seller and is remotely accessed by a customer for use in Tennessee” as subject to tax.
▪️ Texas considers SaaS a ‘data processing service,’ which is taxable.
▪️ Utah’s legislation specifies that remotely accessed prewritten software is taxable if the purchased software is used in Utah. However, remotely-accessed custom software is not taxable. Remotely accessed software includes “hosted software, application service provider (ASP) software, software-as-a-service (SAAS), and cloud computing applications.”
▪️ Washington’s revenue code states that charges for the right to access and use prewritten computer software, where the seller or a third party maintains possession of the software, are taxable.
Though not an exhaustive list, you can see how nuanced details added to state legislative definitions of ‘software’ and other related terms result in muddy SaaS tax regulations.
Why Legislative Complexity Creates Blurred Lines
Just glancing at how the taxability of SaaS is recorded by each state plainly illustrates a need for a more streamlined system. While some states specifically spell out cloud-based software in their general excise tax guidelines, others have no detailed legislation. Instead, SaaS is casually mentioned in a fact sheet or bulletin that takes some determined Google searching to surface.
A handful of states also neglect to mention SaaS altogether, as if it doesn't exist. In this case, businesses and CPAs must infer if SaaS qualifies as 'software delivered electronically' or similar. This doubt often prompts states to submit an inquiry to the offending department of revenue, and answers to these questions sometimes result in the issuance of an opinion letter. These letters offer 'unofficial guidance' but give businesses a leg to stand on when assuming SaaS tax is not required– at least until further legislative details are put in place.
Not all states are ambiguous, though. Some, like California, Colorado, Florida, and Indiana, specify that cloud-based software is not tangible personal property, therefore, is not taxable. Illinois and Georgia define SaaS as a nontaxable service. Kansas created its own category and term for SaaS providers– Application Service Providers (ASPs) - which are nontaxable. When a state overtly says cloud-based or electronically delivered software is exempt from sales tax, you can have confidence that legislation is concrete enough to be reliable.
In any other case, you have to use your best judgment based on information provided in legislative rulings, tangible personal property definitions, opinion letters, and tax bulletins.
These 26 states currently consider SaaS to be tax-exempt:
Arkansas (Regulation GR-25)
California (Revenue & Tax Code §6006)
Colorado (Code of Regulations 60-310)
Florida (Rule: 12A-1.032)
Georgia (LR SUT-2014-05)
Idaho (Code §63-3616(b))
Illinois (86 Ill. Adm. Code 130.1935)
Indiana (Information Bulletin #8)
Kansas (Opinion Letter No. O-2010-005)
Kentucky (Sales Tax Facts 2020)
Louisiana (Revenue Ruling No. 10-001 and suspension of ruling)
Maine (list of taxable services)
Michigan (Department of Treasury Notice, January 6, 2016)
Minnesota (R. 8130.0500, Subp. 2)
Mississippi (Rule 35.IV.5.06 - page 56)
Missouri (Rev. Stat. §144.010)
Nebraska (Information Guide 6-511-2011– currently being updated)
Nevada (Rev. Stat. §372.060)
New Jersey (Technical Bulletin TB-72)
North Carolina (SUPLR 2014-0010)
North Dakota (Cent. Code §Sec. 57-39.2-02.1)
Oklahoma (uniform tax matrix)
Vermont (Stat. Ann. tit. 32 §9701)
Virginia (05-44 Tax Commissioner Ruling)
Wisconsin (Sales and Use Tax Treatment - Computer Hardware & Software)
Wyoming (Wyo. Stat. Ann. §39-15-103)
Additionally, five states don’t have any sales tax– including Alaska, Delaware, Montana, New Hampshire, and Oregon.
Many states don’t tax SaaS because they don’t consider cloud-based software to be tangible personal property. Others have more creative reasoning behind why SaaS isn’t taxed, focusing on things like how it’s served and stored or whom it’s used by and where.
Standout Legislation in States with No SaaS Tax
▪️ Maine has a caveat that software is exempt from tax as long as it’s not downloaded.
▪️ Michigan revised its legislation to specify that “if only a portion of a software program is electronically delivered to a customer, the “incidental to service” test will be applied to determine whether the transaction constitutes the rendition of a nontaxable service rather than the sale of tangible personal property. However, if a software program is electronically downloaded in its entirety, it will be taxable.”
▪️ Minnesota exempts SaaS so long as it’s not purchased, leased, or licensed to a customer who stores it on a server in the state. Mississippi also requires that the software is stored on a server outside the state.
▪️ New Jersey doesn’t list the use of a software application as a taxable service - but does specify that information services are taxable. Therefore, if a client’s SaaS product qualifies as an information service, they may owe SaaS tax in New Jersey.
▪️ North Carolina hasn’t adopted any specific cloud computing regulations but has determined that revenue from access to cloud-based software accessed electronically via the internet is not subject to tax in nonprecedential letter rulings.
▪️ North Dakota states that services that require a fee or subscription to access for use are not taxable.
▪️ Wyoming doesn’t tax SaaS because the purchaser doesn’t have permanent use of the product.
One more state also got creative with SaaS legislation– Louisiana.
Short-Sighted Software Legislation Caused Far-Reaching Impact
A little over a decade ago, Louisiana passed legislation that included a very broad use of the concept of tangible personal property. The law stated that electronically delivered information, data, material, media, or other forms of communication, including software, were tangible (and thus taxable) if they are "felt" by the senses of sight or sound or both, even if the body of information is only viewed in Louisiana on a computer screen and never actually stored on the computer. Further, it explicitly stated that one-time use and subscription-based cloud services all qualified as tangible personal property.
The department's 2010 ruling, Revenue Ruling 10-001, overtly stated that charging for software accessed remotely is taxable. Louisiana supported this decision using details from the outcome of a popular Supreme Court Case, South Central Bell Telephone Company v. Sidney J. Barthelemy.
As they tried the case, the Supreme Court analyzed whether computer software was tangible or intangible to determine taxability. They found, "The purchaser of computer software neither desires nor receives mere knowledge, but rather receives a certain arrangement of matter that will make his or her computer perform a desired function. This arrangement of matter, physically recorded on some tangible medium, constitutes a corporeal body. The Supreme Court further held that the form of delivery was of no consequence."
That ruling made sense when the judge hit the gavel in 1994. However, when Louisiana extracted details from that case to justify revenue ruling 10-001 in 2010, we already lived in a much different world. After facing outcries from businesses suddenly facing significant tax liabilities, the Louisiana Department of Revenue repealed 10-001 in 2015. Initially cited as a 'temporary suspension of policy,' the repeal has held firm to date.
Subscription-Based SaaS Creates Nexus Nightmares
Subscription-based SaaS products tend to operate on a rolling period. That means payments come in every day of the month, and there’s no clear start or end to billing cycles. That being the case, it can be extremely difficult to predict when nexus will be triggered because you’re always dealing with seasonality, churn, and all sorts of other outside factors that impact the amount of money your clients are paying into a particular state in any given month.
You can be proactive about potential trigger states and help clients see where they’re at risk by completing a full nexus study on their behalf. Taking this approach not only simplifies compliance and reduces audit risk but also allows you to flag vulnerable clients and offer more profitable advisory services designed to protect their business.
Take the Mystery Out of SaaS Tax Compliance
As an accountant, clients look to you for expert advice. The problem is, you don't have the time to dredge your way through endless legislation, tax bulletins, and court case rulings to read between the lines and figure out where your clients owe SaaS tax. Legislation changes all the time, and it requires extreme diligence to stay up-to-date on what's happening across 51 states - and to verify that what you’re reading is accurate. If you’re tired of the pain caused by constant legislation changes, let LumaTax bear that burden for you. Ready to take advantage of having real-time access to all the answers? Request a demo today.