14 Common Sales Tax Mistakes in SaaS Businesses and how to avoid them

If your SaaS business is growing nicely and expanding its reach, then it’s likely your sales tax 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, 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 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.

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.

Ensure that your sales tax operations are compliant with our complete list of 14 common sales tax mistakes in SaaS and learn how to manage it in 5 effective steps on PayPro Global’s blog.