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SaaS founders need to know these tax rules

Running a Business

Do you have a remote team? Affiliate sales or marketing partners? Are you using PPC (pay-per-click) ads that direct users to make purchases? Then you’d better be clear on whether or not you’re required to pay sales tax in the state(s) where you’re making those transactions and sales.

Getting your taxes in order tops the due diligence list. Investors and potential buyers don’t want to see that your company owes all kinds of tax dollars, nor do they want to see that you’ve overlooked something so important. Plus, none of us want trouble from the IRS! I’ve seen startups go out of business because they owed giant fees to the IRS for not paying taxes correctly.

Besides the typical Federal, State, and Local taxes you pay as a registered business – there are specific tax rules that SaaS founders need to know.

We’re not accountants by any means, but we wanted to lay out some of the most critical tax regulations for SaaS founders to keep top-of-mind.

How sales taxes work for SaaS

Sales taxes (state/local taxes paid on the purchases your customers make) get tricky with SaaS companies because we aren’t selling something tangible. Our customers don’t get a CD with software or a download link. Instead, they log in and access our platforms via cloud. Since this is a newer concept, state governments are still debating on how to tax for these services.

In many states, you’ll be exempt from sales tax. In others, you’ll be required to pay. For example, the state of New York has a law that says any prewritten software is a taxable product, regardless of how it’s accessed (Regulation 20 NYCRR §526.7(e)(4)). So, you and your accountant should do your homework on which states will require what from you.

Here’s a link that will tell you whether or not you should look into sales tax within any given state.

What qualifies as a presence (nexus) in a given state?

If you sell your software in states besides the state your business is registered in, you may be required to file documents establishing “nexus.” Nexus means you have an established presence in that state where you sell your software, and therefore, can collect sales tax there.

The qualifications for a “presence,” or nexus, differ from state to state. When it comes to SaaS companies, there are two types of presence:

A physical one – you’ve got an address, coworking space, or an office there

An employee, contractor, partner – someone who represents your business either works IN that state or goes there to sell your product.

Most states define nexus like this:

Maintaining, occupying, or using permanently or temporarily, directly or indirectly or through a subsidiary, an office, place of distribution, sales or sample room or place, warehouse or storage place or other place of business.

*Also, having a representative, agent, salesman, canvasser, or solicitor operating in this state under the authority of the retailer or its subsidiary on a temporary or permanent basis.*


Types of nexus

Click-through – when a service provider or web service sends a customer from a weblink to your site, and they make a purchase. Pay-per-click, banner ads, Google ads, etc. do not count if your customer doesn’t make a purchase directly after clicking the ad. So an ad campaign focused on lead generation and not direct sales wouldn’t require nexus.

• Economic – If you meet a threshold in sales dollars, you must pay sales tax. If you land under both threshold amounts, you’re exempt. According to Quaderno’s Ultimate Guide to US Economic Nexus, each state defines its own thresholds.

• Affiliate – Someone (either outsourced company or sales rep) represents your business in that state and makes sales on your behalf.

• Marketplace – eCommerce companies have to pay tax if they are selling in a state, providing customer service to customers in that state, are marketing to the area, and processing payments from the state.

Establish nexus in the necessary states for your business. Don’t try doing this all on your own, ask your accountant! Check here for specific nexus types and requirements in various states.

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