14 Common Sales Tax Mistakes in SaaS Businesses and how to avoid them
If you are selling SaaS online and your business is growing nicely, expanding its reach, then your sales tax SaaS compliance requirements may very well be changing too! Sales tax in the U.S. can be, well, taxing — but, unfortunately, you can’t afford to drop the ball. The stakes are simply too high.
That’s why we’ve made a list of the typical sales tax mistakes SaaS companies make to help you stay on the right side of the law. If you still have questions after reading this article or on how you could better sell software online, give us a shout. We’re an email or a phone call away and always ready to assist.
What Is Sales Tax?
Before we delve into the sales tax mistakes many SaaS companies make, let’s first clear up a couple of terms so that we’re on the same page.
Sales tax is the tax collected by a retailer from a customer whenever a sale is made. The retailer then remits the money to the relevant tax authorities as the law requires.
Are SaaS Products and Services Taxable?
Software-as-a-Service (SaaS) is taxable in many countries worldwide, and the number continues to grow. When a customer purchases from your SaaS business, you may need to collect tax in the jurisdiction where the customer bought your product. Take the U.S., for example:
In states where SaaS products are taxable, two broad categories apply:
Tangible personal property
Computer or data processing services
Some U.S. states classify SaaS as a product, while others consider it a service. Needless to say, this is a situation that often causes confusion and frustration.
Sales Tax Collection Obligations for SaaS providers
While sales taxes on SaaS products have now been legalized in more than 40 countries globally, there is little consensus between them. That is especially true of the U.S., with each state operating independently when creating tax laws.
SaaS companies must register in U.S. states where they have physical nexus or where they exceed economic nexus thresholds (read our article on SaaS Online Sales Tax 101 for more information). In short, they are required to collect tax in those jurisdictions, which is then filed and remitted to the state according to the frequency needed for each jurisdiction.
Where Do You Need To Pay Sales Tax?
If your business has a physical or economic nexus in a state or specific jurisdiction, you’ll have to pay sales taxes there. Before the 2018 South Dakota vs. Wayfair Supreme Court ruling, sales tax was triggered by nexus, which meant a business had to have a physical presence in a tax jurisdiction to qualify for sales tax.
However, the Wayfair ruling brought about drastic changes for many businesses. It mandates that even if you don’t have a physical presence in a particular state and the purchase is made online, you may still be required to register in that state and collect sales tax.
This requirement is enacted whenever you exceed the economic nexus threshold. So, if your business is based in Texas, but your customers all seem to be buying your products in Ohio, you may be required to collect sales tax if economic nexus is reached there.
14 Frequent SaaS Business Sales Tax Mistakes
Now let’s take a closer look at the typical sales tax registration and filing errors businesses make to help you avoid time-consuming, costly, and most importantly, legal mistakes.
Misunderstanding Economic Nexus Laws
Gone are the days when nexus was just a physical presence in a state or jurisdiction. These days, it’s easy for a SaaS business to reach and exceed economic nexus thresholds and not even realize it. Sometimes this can happen even when you’re selling your subscription products to a relatively small number of customers.
It is essential to understand the concept of economic nexus and how it affects your business. Economic nexus varies from state to state but is usually measured by a total dollar amount or number of transactions made. Not complying with nexus laws can lead to back taxes and penalties, which could be detrimental to your business’s financial health.
Failing To Monitor Different Tax Jurisdiction
Another widespread mistake is not keeping current with the different tax jurisdictions as their rules and regulations are often modified.
There’s no federal sales tax in the U.S., and the situation is much more complex than each state just forming one tax jurisdiction. The reality is that there are over 11,000 different sales tax jurisdictions in the country, which makes it very difficult to ensure SaaS compliance at all times.
It’s vital to keep yourself informed on where, when, and how much sales tax you need to pay. As a SaaS business, it’s more than likely your sales will fall into multiple tax jurisdictions. When was the last time you checked this?
To further complicate the matter, sales tax regulations are in constant flux, so keeping your finger on the pulse to ensure you remain tax compliant is neverending.
Collecting Incorrect Tax Amounts
Businesses often fail to fully comprehend the specific tax rates that apply to them and can also misunderstand the taxable periods. As a result, they file the wrong amounts, which can be a devastating error responsible for lost time and money.
Even if filing sales tax incorrectly was an honest mistake, it could lead to severe penalties. Our advice: get professional advice if you’re not 100% sure what you owe the tax authorities.
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Misunderstanding Taxable Items
Did you know that each state defines Saas differently? This is because it doesn’t fit neatly into the “tangible personal property” or “specifically enumerated services” categories.
Because of this, your SaaS product may not be taxable in your home state but could be taxable where your customers are making purchases. The combination of sales tax requirements will look different for almost every business.
Therefore we highly recommend that you clarify where you are submitting documents or have an established nexus, and then investigate how those states interpret sales tax compliance for SaaS products.
Missing Sales Tax Exemptions
A sales tax exemption certificate allows a purchaser, for whatever reason, to buy a product tax-free when the product is usually subject to sales taxes. By now, it probably comes as no surprise to you that sales tax exemptions vary by state and local government and change from time to time. We recommend you check annually whether any of these exemptions apply to your product.
Failure to keep up with tax exemptions can cause serious tax complications. If a certificate for exemption expires or is invalid, you could be liable for uncollected taxes. Therefore, it’s vital to develop a system to monitor tax exemptions and certificates to prevent lost revenue.
Not Filing Because You Didn’t Collect Any Tax
Some businesses think they don’t need to file a tax return because they didn’t collect any tax over a specific period. However, many states require you to file at the end of every reporting period, even if you collected no taxes meaning you must still file a “zero return.”
Again, failing to file sales tax can lead to penalties for lateness or non-filing, and your account could then be labeled non-compliant.
Incorrect Tax Reporting and Computation Errors
In many states, filing sales tax means looking at how much you’ve collected based on a county, city, or even a smaller tax jurisdiction such as a zip code. To state the obvious: you should check very carefully to ensure your sums are correct! Sales tax compliance can become an absolute nightmare if you sell on multiple channels.
We say this because the math can get very confusing, and different states’ requirements make it even more so. For example, some states may require you to round numbers up, while others need you to round them down. Again and as always, keep up to date with these rules and watch out for computation errors, leading to non-compliance.
Filing Late or Not Often Enough
Keeping track of filing deadlines can be a headache if your business has nexus in multiple states and jurisdictions. But be warned: auditors see filing late as a red flag. If you miss a filing deadline, you’ll have to file eventually, and you still could face penalties or fines.
To avoid this costly mistake, create a filing schedule and review it regularly to track any changes in the different jurisdictions and act accordingly!
Forgetting Important Information
In some cases, tax authorities can reject your tax form just because you’ve left off a small detail. For example, something as simple as a signature left off a page can invalidate a document.
It should go without saying, but check each document carefully before submitting it, or better yet, do your filing online to reduce missing out on any of the required fields.
Not Challenging Negative Audit Findings
If you are worried about negative audit findings, start by reviewing your rights and responsibilities and get professional help if you need to. Filing an appeal to challenge negative results can benefit your business in the long run.
Miscommunication With Customers
Your marketing and sales materials must make it clear that you’re collecting sales tax on customers’ purchases. If your customers aren’t aware of this, you could lose sales and ultimately the customers themselves.
Most customers will expect you to include the sales tax in the listed price in the online space. If this isn’t the case, make sure it is abundantly clear.
Failing To Keep Up With Changing Regulations
We understand that staying up to date with changing laws and regulations can be difficult for even the most organized business owner.
Vertex Inc.’s End of Year 2020 Sales Tax Rates and Rules report shows that a total of 223 city rate changes and 177 new district taxes were implemented in 2020. That’s a lot to keep track of!
Make it a priority to monitor each jurisdiction where you have physical or economic nexus, and be sure you understand any changes regularly.
Sales Tax Automation Mistakes in SaaS
Many large businesses utilize sales tax software to manage the complexities of their tax compliance requirements. It’s comforting to know it’s possible to automate sales tax collection, as well as filing and remitting, when we know how complicated these tax laws can be.
Automation has many benefits, but the process also has some drawbacks. For example, the nexus footprint could change, filing frequencies may be updated without realizing it, or you could miss electronic notices on state websites.
These scenarios all require human intervention and perhaps even the knowledge of a sales tax expert. One solution is to automate specific parts of the process, but not all of it, so that you can maintain control of the various moving parts.
Trying To Do it All on Your Own
There’s always a lot to manage in a growing SaaS business with expanding sales. Unfortunately, worrying about sales tax can get lost in the many responsibilities of running a company when things get busy.
If your business struggles to manage the tax return process, you can always turn to the experts. You’re likely to save time and money, as non-compliance can cost you dearly in the long run.
No 3rd party integrations. No hidden costs. No wasted time.
Just a solution as unique as your business’s needs.
5 Tips for Managing Sales Tax and Avoiding Mistakes in SaaS
Track Every Dollar
To stay informed about your sales tax obligations, keep thorough records. Track your invoices and sales very carefully so that you’re aware of where all your purchases are coming from.
A good accounting service can help here. These experts will know whether or not you need to collect sales tax on each transaction.
After consulting with them, you’ll be able to investigate the various requirements of the relevant jurisdictions. Once again, professionals can assist if you get stuck.
Keep on Top of Payment Deadline Dates
Remember, the timing of when you need to remit the sales tax you’ve collected on purchases varies by state. Each state has a filing frequency, most commonly monthly, quarterly, or yearly. Usually, this means that payments take place on a set date.
However, consider that holidays and weekends may affect these frequencies.
Our advice? Keep an online calendar with the dates marked for each state where you must collect and remit taxes (don’t forget to add reminders). Then, update this calendar as the dates change or other factors influence when you need to file your tax.
Know-How To Remit Sales Tax
Each state has a different way of accepting sales tax payments. Therefore, carefully investigate the methods accepted by the various states where you have nexus and make sure you always remain compliant.
Remember: Each state has its own website with comprehensive information on its sales tax requirements.
Get the Proper Permits
Every time you’re required to pay tax, you’ll need a sales tax permit to do so. When your sales exceed the nexus threshold in a state, you will need to get a sales tax permit for that state to be compliant.
Understand the Penalties
Nobody wants to be caught unaware and slapped with a hefty fine or legal action, as obviously, this can do severe damage to your growing business.
We strongly suggest you do some research into the penalties for non-compliance. The penalties you're avoiding will keep you motivated when you establish processes to keep track of the different requirements.
Final Thoughts on Common Tax Mistakes in SaaS Businesses
We get it. We know how long it takes to run a company and be successful. Navigating the complex world of sales taxes can feel like a full-time job when your Saas business is growing at such a fast rate.
Are you feeling overwhelmed? Do you need help to ensure that your SaaS tax operations are compliant? Get in touch if you’re in the SaaS business — we’re here to help you avoid those common sales tax mistakes, and we want to help you continue to grow your business!
Frequently Asked Questions
Do SaaS companies have to charge sales tax?
Generally, yes. Sales tax is a tax assessed by states on the sale of goods and services. It's imposed at the point of sale, and the seller is responsible for collecting it from the customer and remitting it to the state.
Do SaaS companies pay VAT?
In most cases, yes. For example, if a company is providing a "bundled service" that includes both software and services, then the company is considered to be providing a service and would have to charge VAT on the entire amount.
Which saas tax rate has each country in the world?
In order to help you avoid costly surprises, we have created a list, giving each country a score based on its tax complexity: SaaS and Software Tax Panic Scale
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