State nexus has become a crucial consideration for Software as a Service (SaaS) companies. As your customer base expands across state lines, it creates new revenue opportunities and challenges for your tax planning strategy. Nexus, the legal term that determines a company’s tax obligation in a state, has evolved significantly with the rise of digital business models. For SaaS businesses, understanding the nuances of nexus laws is key to managing compliance, avoiding costly penalties and staying ahead of regulatory changes. Navigating the complexities around state nexus is essential to avoid over or under-collecting taxes.
Impact of Economic Nexus on SaaS Companies
Historically, tax nexus was defined by physical presence—if a business had employees, offices or warehouses in a state, they were required to collect and remit taxes there. However, the South Dakota v. Wayfair Supreme Court decision in 2018 introduced economic nexus, significantly expanding the definition. Under economic nexus, businesses must collect sales tax if they meet a certain sales threshold or transactions in a state, regardless of physical presence.
For SaaS companies, this shift is particularly significant. Since most SaaS products are delivered digitally, it’s easier for these companies to have customers in multiple states without a physical footprint. If your SaaS business meets the economic nexus thresholds set by a state, you may be required to collect and remit sales tax in that state.
Is SaaS Taxable?
Determining whether SaaS products are subject to sales tax is another layer of complexity. States differ in how they classify SaaS, with some considering it taxable and others exempt. In states where SaaS is taxable, the taxability might depend on how the software is delivered—whether it’s considered a product, a service, or electronically transferred software.
Some states like New York and Texas classify SaaS as tangible personal property or a taxable service, meaning you’ll need to charge sales tax if you have nexus there. The following states have laws in place that at least partially tax SaaS:
- Arizona
- Connecticut
- District of Columbia
- Hawaii
- Iowa
- Louisiana (1/1/2023)
- Massachusetts
- Maryland
- Minnesota
- Mississippi
- New Mexico
- New York
- Ohio
- Pennsylvania
- Rhode Island
- South Carolina
- South Dakota
- Tennessee
- Texas
- Utah
- Washington
- West Virginia
Determining Nexus and Taxability for SaaS Companies
1. Identify Where You Have Nexus
SaaS companies must regularly assess where they meet nexus thresholds. Given the dynamic nature of state tax laws, maintaining a clear view of where your business exceeds economic nexus thresholds is critical. Utilizing automated software or partnering with a tax advisor can help track where you’re reaching the nexus thresholds.
Tip: Many states impose their own unique thresholds, so it’s important to stay informed about changes to economic nexus rules, especially as your business grows and expands into new markets.
2. Determine SaaS Taxability in Each State
The taxability of SaaS varies by state. Partnering with tax professionals who stay up-to-date on state regulations can help you avoid missteps. Each state has unique rules on what is taxable, how to classify software sales and how to report taxes, making it easy to overlook a requirement.
Tip: Conduct an in-depth review of the states where your company operates to determine if SaaS is taxable. This will allow you to apply the correct sales tax rates and avoid penalties.
3. Compliance with Sales Tax Collection and Remittance
Once nexus is established and taxability determined, your SaaS company must collect, report and remit sales taxes in applicable states. Compliance requires timely filing and accurate reporting, which can be time-consuming and challenging as your business grows. Outsourcing this function or using automation software can simplify the process and ensure you stay compliant.
Tip: Automate your sales tax calculations and filings where possible. This reduces the risk of human error and helps ensure that your business complies with state requirements.
4. Stay Updated on Regulatory Changes
State tax laws evolve rapidly, particularly in SaaS, where digital products challenge traditional tax regulations. Even states that don’t currently tax SaaS could change their laws in the future. Regularly reviewing tax laws and keeping an eye on pending legislation is crucial for long-term compliance.
Tip: Engage a tax advisor or legal team to stay on top of changes in the nexus landscape. A proactive approach will help your company avoid surprises and plan for future obligations.
As SaaS companies continue to scale across multiple jurisdictions, understanding and managing state tax nexus becomes essential for sustainable growth. Navigating the ever-changing nexus landscape requires diligent tracking of sales, understanding taxability rules and maintaining compliance with state regulations. By staying informed and seeking expert advice, SaaS companies can mitigate tax risks and ensure seamless operations.
Anders State and Local Tax advisors can help you navigate the complexities of state nexus laws, ensuring your SaaS business stays compliant and avoids unnecessary penalties. Learn more about how our advisors can support your tax strategy and compliance efforts, and the associated costs, by requesting a meeting below.
