Companies that sell software as a service, or SaaS, may think the recent Supreme Court of the United States decision in South Dakota v. Wayfair, Inc. doesn’t impact them. But it can, and in several states, it already does.
Though cloud-based services like SaaS are relative newcomers, they’re already subject to sales and use tax in more than a dozen states, including Hawaii, Indiana, Louisiana, Massachusetts, Mississippi, New Mexico, New York, Ohio, Pennsylvania, South Carolina, South Dakota, Tennessee, Utah, Washington, and Washington, D.C. Many of these states already or soon will require out-of-state sellers to collect and remit sales tax on their sales into the state.
It used to be that SaaS companies — indeed all companies — were only required to collect and remit sales tax in states where they had a physical presence; states lacked the authority to tax sales by remote businesses. Thus, companies that trade in SaaS, which often don’t have a physical presence in all states into which they sell, have been somewhat protected from sales tax obligations in other states.
That changed on June 21, 2018, when in its ruling on South Dakota v. Wayfair, Inc., the Supreme Court found the physical presence requirement to be “unsound and incorrect.” The court determined that a sales tax collection obligation (nexus) could be established through a business’s “economic and virtual” contacts with a state (economic nexus).
Almost 30 states have adopted economic nexus in the few months since the decision was released. And many of these states tax cloud-based services like SaaS.
Economic nexus can apply to SaaS sales, too
Hawaii, Louisiana, Mississippi, South Carolina, South Dakota, Utah, and Washington are among the states that have adopted economic nexus and tax the sale and use of SaaS. That list is growing. On October 1, 2018, SaaS became subject to tax in Rhode Island, which requires remote sellers doing a certain amount of business in the state either to collect and remit sales tax on their Rhode Island sales, or comply with use tax notice and reporting requirements for non-collecting sellers. And SaaS will become subject to sales tax in Iowa on January 1, 2019, the same date the state’s economic nexus law takes effect.
Most, though not all, of these states are emulating the South Dakota law that set the Wayfair case in motion. It maintains a business with no physical presence in South Dakota has sales tax nexus if, in the current or preceding calendar year, it has more than $100,000 in gross sales in the state, or 200 or more transactions delivered into the state.
The very nature of the SaaS business model puts SaaS companies at risk of establishing economic nexus in multiple states. Most SaaS companies use a subscription model, charging customers on a monthly or annual basis for the service, and it doesn’t take long to reach 200 transactions per year when customers are billed monthly. Instead of making one sale to 200 customers in a state, SaaS sellers making 12 sales per year to fewer than 20 customers could establish economic nexus in states that have a transaction threshold.
More states could soon tax remote sales of SaaS
Information technology research company Gartner calls SaaS “the largest segment of the cloud market, with revenue expected … to reach $85.1 billion in 2019.” Thus, it stands to reason that more states are looking to tax SaaS transactions. The fact that they now have the authority to tax remote sales makes them all the more likely to do so.
Businesses shouldn’t assume that a state that doesn’t tax SaaS and similar cloud-computing services today won’t tax them tomorrow. As indicated by Rhode Island and Iowa, any state with a sales tax could decide to tax cloud-computing services at any time. Similarly, any sales tax state that hasn’t already done so could adopt economic nexus at any time. Scott Peterson, Vice President of U.S. Tax Policy and Government Relations at Avalara, predicts all states with a sales tax will adopt economic nexus by 2020.
Assuming economic nexus laws only impact tangible good sellers is risky; with new taxing powers at their disposal, states are increasingly likely to tax remote sales of SaaS. Sellers of SaaS and similar cloud-computing products should keep close watch on state sales tax laws and consider undertaking a nexus study to determine where they have nexus now, and where they’re at risk for establishing it. A good first step is to check out this state-by-state guide to economic nexus rules.
By Gail Cole
