U.S Sales Tax: The Nightmare of Scaling a SaaS Business
Your sell software online, and your eCommerce business is experiencing rapid growth. You’re scaling your operations and increasing your reach across the U.S and into new global markets. Excellent news, right?
Well, yes and no.
One thing is for sure: as your SaaS company scales, staying compliant with the SaaS online sales tax becomes increasingly more complex, both in the U.S and internationally. The importance of prioritizing compliance cannot be overstated.
What Is Sales Tax?
Sales tax is a consumption tax that the U.S government charges on the sale of goods and services. Retailers generally collect sales tax at the point of purchase and then pass it on to the government. Since the birth of eCommerce, this has been a somewhat confusing endeavor, and digital goods have made it even more complex.
In short, your business is liable to pay tax in a specific state or jurisdiction if it has a nexus there. But more on this later.
Why is U.S SaaS Sales Tax So Complex for Scaling Businesses?
Many factors contribute to the complexity of sales tax compliance and financial reporting within the United States, and each one is crucial for SaaS companies to understand. Let’s start with the most critical elements to get to grips with if you are scaling your business:
Understanding U.S Nexus Legislation
What Is Nexus
When talking about sales tax rules in the U.S, ‘Nexus’ refers to the level of connection between a specific taxing jurisdiction and an entity. The taxing jurisdiction can be a state or a district, and the entity, in this case, is the business itself. When this connection is established, a taxing jurisdiction can impose taxes on SaaS companies.
Physical and Economic Nexus
A physical nexus means that any business with sufficient physical presence in a specific jurisdiction must pay tax rates there. This presence includes having a property in a jurisdiction or employees working there.
Economic nexus refers to a threshold of economic activity after which a business must pay taxes in a particular jurisdiction. This is usually measured in terms of a monetary threshold, the total number of transactions over a specific period of time, or both.
The Impact of South Dakota v. Wayfair
As online sales increased across the U.S in the 2010s, states became aware they were losing billions of dollars of sales tax. As a result, they began to push for a new standard of compliance.
Before 2018, nexus in the U.S generally referred to physical nexus, and you would only have to pay sales tax if you had an actual presence in a state.
However, after the judgment of South Dakota v. Wayfair in June 2018, sales tax in the U.S became much more complicated for online sellers. The Supreme Court agreed with South Dakota that states should be collecting sales tax where businesses have economic nexus. Since this precedent was set, most states have followed suit and imposed their own nexus standards.
So, if you sell SaaS online, Software, or digital goods and services within a U.S state, you may be required to register and pay sales tax in that state regardless of whether or not you have a physical nexus there.
Additionally, it’s essential to clarify that you are not exempt just because the transaction takes place online. If your sales exceed the nexus threshold in a state, you’ll need to pay taxes.
It is safe to say that with all these legal changes, many businesses have had to scramble to comply with audits as states try to reclaim lost revenue.
Differing state and District Regulations
Currently, there are over 14,000 tax jurisdictions in the U.S, each with its own rates, rules, and regulations, making staying on top of taxes incredibly confusing and time-consuming.
In the U.S, sales tax legislation is different in every state, charging differing base rates. Then each jurisdiction within a state can add more tax on top of that. For instance, a county could impose an additional sales tax, while a district could impose yet another tax on top of the previous two.
This means that the total could be significantly more than the state rate would typically be.
Different states set different sales thresholds, and they may also have different evaluation periods and registration timings. Because of these complexities, it’s essential that SaaS leaders and founders check each state’s nexus laws.
To help you better understand the complexity of global tax compliance, we have created our SaaS & Software Tax Panic Scale which you can access below.
It gives each U.S state (and many other countries, states, and provinces around the world) a score based on a range of factors, including its tax rate and tax registration complexity.
New Products and Services
SaaS, Software, and digital goods companies notoriously suffer from the complexity of taxability. Each time you add a product or service to your arsenal, it potentially creates complicated changes to your sales tax nexus. Software is taxed according to numerous categories and criteria, and the system hasn’t always kept up with changes in technology.
Since products can be taxed at different rates depending on who purchased them, where they bought them from, and whether the item is taxable in a particular state or jurisdiction, this situation is destined to cause confusion and frustration for company owners, no matter their experience or business size.
Filing Tax Returns for Multiple States
There is simply no way around it; you must register for sales tax in every jurisdiction in which you have nexus. As mentioned before, this could mean you’ll have to keep track of different filing deadlines and requirements for multiple states.
The frequency of filing differs in many states. Also, you may need to pre-pay part or all of your sales taxes, which may change as your sales grow in a jurisdiction.
In short, it often becomes clear very quickly that if you have nexus in many states, it may become too much to handle in-house.
The Intricacies of Filing Tax Returns
There is a saying, “the devil is in the details,” and it seems very fitting regarding tax. Different tax return forms require so much varying information that it can be easy for even the most competent SaaS company to mismanage this task.
For instance, a state can reject a return for something as small as leaving off a signature, and some states require you to round amounts up, while others need them rounded down. Because of these intricacies, we caution SaaS businesses to seek the help they need to mitigate bringing this type of hurdle into managing your business.
Managing Historical Liability
Some states allow voluntary disclosure agreements, which means you can remit sales tax liability with limited look-back periods and no penalties. But If you realize you are liable for backdated sales tax, you must have a solid plan before filing them.
To summarize, It’s always better to get out in front of historical tax liability. A good motto, in this case, is don’t ignore it and hope it will go away!
Differing Taxable Periods
Because individual states set their own taxable periods, some will want you to file your taxes annually, while others require you to file quarterly or monthly. Dealing with the differing taxable period requirements can be overwhelming, which is another reason for considering outside help with your taxes.
If you are unsure if you can manage all aspects of tax compliance, it is better to err on the side of caution and ensure that knowledgeable professionals are managing this side of your business.
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8 Key Sales Tax Considerations When Scaling Up Your SaaS Business
Please consider the following checklist as you look to grow and expand your business. If you cover all these areas, you will be well on your way to ensuring sales tax compliance throughout your business. However, the best way to cover all sales tax-related issues is to work with a Merchant of Record.
Your business needs to register in every state with an economic or physical nexus.
You’ll be given a sales tax identification number for each state your company registers in. But before you register your SaaS or software business, make sure you understand all state income tax obligations!
You should be completely clear on what is taxable and what isn’t in every state that you have customers. Because this can differ quite drastically from state to state, it bears repeating; Do not underestimate the complexity of tax laws, or you could find yourself in a heap of trouble.
B2B vs. B2C
Within the U.S, Business-to-Business (B2B) transactions are typically taxed. However, this depends on the jurisdiction. Business-to-Consumer (B2C), on the other hand, isn’t always taxed.
However, instances of B2C tax are growing, and you’ll be taxed for B2C more as time goes on. Quite a few jurisdictions don’t recognize any difference between B2B and B2C in terms of taxes. If you are not sure, it is advised to consult a tax professional.
Threshold and Tax Rate
If your sales are quickly changing or growing, it is even more critical to understand the threshold you need to begin paying taxes in a jurisdiction. Once you have reached this threshold, investigate the specific tax rate in that jurisdiction. Again, a thorough understanding of what is expected is key to running your business legally and within all necessary compliance.
As you scale your business, it becomes more likely that you will be audited. Make sure you know how long you need to keep records for all purposes. Also, ensure you’re always ready with relevant evidence of your taxable and non-taxable sales.
Lastly, remember to collate your tax payments and tax credits. Being prepared for an audit will also increase the chances of success throughout all company processes.
Filing and Remittance
As mentioned earlier, you need to keep track of when you need to file in different tax jurisdictions. For example, should you file monthly, bi-monthly, quarterly, or annually? Filing dates differ from state to state, so make sure you’re aware of each jurisdiction and that you leave yourself plenty of time to prepare.
Penalties for Non-Compliance
The penalties in the U.S for non-compliance when it comes to taxes can sink growing SaaS companies. Nothing is worth the risk of being found non-compliant when it comes to your business!
Be warned - the penalties vary depending on whether there appears to be malicious intent or not and range from backdated payments and fines up to criminal charges.
As is the case in many different industries, laws and regulations regularly change to keep up with how we do business in the world of SaaS solutions. These changes are particularly noticeable in software services that are continuously developing and growing. While it can be challenging to keep track of changes, it's vital to keep your finger on the pulse and remain tax compliant.
U.S Sales tax compliance, as global SaaS compliance in general, can be an absolute nightmare for SaaS, digital goods, and Software companies of any size - and that’s putting it nicely!
If keeping up with the complex and ever-changing rules and regulations feels like a full-time job, that’s because it is. However, you don’t need to navigate global sales tax on your own. PayPro Global's Merchant of Record for gaming companies and SaaS can be of great help!
How is sales tax calculated?
The formula for calculating the simplest sales tax rates is relatively straightforward: Tax Rate x Cost Of Item = Total Sales Tax.
Why does sales tax vary from place to place?
Sales taxes vary from place to place for two reasons. (1) Because different states have different rates of sales tax. (2) Because some tax rates are only applicable when a company has reached a sales volume threshold.
How PayPro Global Can Help With Your Global Taxes.
Removes risk for your business by taking responsibility (and liability) for calculating, remitting, and filing your sales tax, both locally and internationally.
Saves you time and money by maintaining partnerships with trusted local payment infrastructures legal entities in other countries.
Ensures you avoid unexpected fines or penalties with an in house team of compliance professionals dedicated to keeping ahead of the latest international tax rules and regulations.
Remember, you don’t have to navigate SaaS tax on your own. With years of experience behind us, PayPro Global is here to assist SaaS, Software, and Digital Goods businesses with our unified eCommerce solution — get in touch to find out how we can help you stay compliant.
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