Just like filing your income tax returns or hanging that state-mandated safety poster up in your break room, sales tax is a back-office pain point, not a profit center.
That makes sales tax compliance easy to ignore… until it becomes a problem.
This post will walk you through what SaaS companies need to know about sales tax compliance, how to know when and from which customers you should collect sales tax, and best of all, how to automate sales tax so you can check “Do something about sales tax” off your to-do list once and for all.
Why is sales tax such a pain for SaaS companies?
There are a few reasons. Sales tax is governed at the state level, not the federal level, so instead of dealing with one set of convoluted tax laws (hi, IRS.GOV), you get to deal with sales tax laws in some or all of the 46 US states with a sales tax.
To complicate matters, each state gets to set their own sales tax laws about everything from, “Is SaaS taxable?” to, “When and how often is sales tax due to the state?”
And, these laws often completely contradict one another.
To top it off, your sales tax responsibility depends on where your customer is, not where you are. So even the freshest new SaaS startup celebrating their 50th customer may find themselves dealing with sales tax in multiple states.
Last but not least, if your sales tax noncompliance gets too out of hand, dealing with multiple states’ sales tax laws means that 46 state departments of revenue can potentially come after you for back taxes. And, nobody wants to cancel the company bonuses or worse, turn off an interested VC, because of a totally preventable sales tax disaster.
But don’t worry, because TaxJar has your back. Here’s what SaaS businesses need to know about simplifying sales tax.
1. Understand your sales tax responsibilities
The first step to sales tax compliance is knowing if what you sell is even taxable. Software as a Service is currently taxable in about one-third of US states, and that number is only growing as outdated state sales tax laws slowly catch up with the way we’re doing business today.
The next thing you need to know is whether you have sales tax nexus in those states. Sales tax nexus is just a fancy way to say that you are responsible for collecting sales tax from buyers in a state. And determining this can be tricky.
For example, you can establish “economic nexus” in a state simply by crossing a dollar threshold of sales in a state, or by making a small number of sales (usually around 200) in a state per year. TaxJar’s Economic Nexus Insights tool can warn you if you are approaching, or if you already have, economic nexus in a state and should be collecting sales tax from buyers in that state.
There are other ways to establish nexus, too. Say you sell a subscription-based software but you also send your customers a handy flash drive with a version of your software on it. Suddenly, you’re on the hook for sales tax in more states since that flash drive is considered taxable “tangible personal property.” And I could go on all day with these nitpicky examples. Suffice it to say that it isn’t exactly easy to figure out where you are required to collect sales tax.
Once you’ve figured out where you have sales tax nexus, the next thing to consider is that each state that does levy taxes will have varying rates and reporting requirements. This expertise can be hard to come by or come at a cost (i.e., hiring in-house talent).
Scaling companies that need insight can get it easily with the help of a specialized platform that guides them through all the necessary and applicable sales tax obligations and processes.
That’s what Basecamp, a leading project management software provider, chose to do when partnering with TaxJar
“The initial appeal was just how easy it was to work with the system,” CTO and Cofounder David Heinemeier Hansson said, “that we knew rates were up to date and we were billing our customers for the right rates and we could defend that when we were submitting our paperwork.”
2. Identify and mitigate risks
There’s no chapter on sales tax in the Comprehensive SaaS Business Owner’s Manual. (What, you didn’t get yours?). When you’re just starting out and juggling all the aspects of your SaaS business, sales tax is easy to overlook. So, here’s what you need to know about risks.
As mentioned above, 46 US states have a sales tax, and all of their sales tax laws are different. The risk in failing to comply with one state’s sales tax laws is that you could be subject to an intense audit where the state’s auditor scours your books for every instance of uncollected sales tax.
The worst case scenario here is that you owe the state any sales tax you should have collected from your customer at the point of sale or when they pay their periodic subscription free. And don’t think for a minute that the state isn’t going to attach late fees and other penalties to that amount.
And, not to get too scary, but sales tax obligations can’t be discharged by bankruptcy. If things get really, really bad, then you could be personally liable to pay sales tax.
The real sting in this scenario is that it’s entirely preventable because you could have been collecting sales tax from your customers all along.
While this is less likely, there’s also a risk of damage to your reputation. The last thing you want is to make the news because a state comes at you for unpaid sales tax.
3. Leverage automation to support scaling
As mentioned, state laws and taxing rates are extremely fluid. Monitoring these changes is more than a full-time job and can place significant pressure on growing companies to stay up to date.
Manually trying to keep up with every small sales tax law or process change is out of the question here. They are prone to error (which further increases risk), not to mention time-consuming. Especially when you’re on the road to $100 million and need to concentrate on actual profit centers in your SaaS business.
This is the exact scenario that KiwiCo, a subscription-based educational toy company, encountered. Its solution was to work with us here at TaxJar to stay current and automate sales tax compliance.
“Without AutoFile we would have needed multiple people to manually process sales tax,” COO Bill Onderdonk said. “But with AutoFile, we’ve scaled to doing taxes in 40+ states.”
4. Focus on the customer experience
It’s easy to get tunnel vision on how sales tax affects internal operations. Yet sales tax also impacts the customer experience.
Any friction in the checkout process — like miscalculated sales tax — could lead to an abandoned cart. In fact, according to eCommerce research think tank, the Baymard Institute, 53% of customers who abandon their cart cite extra fees like sales tax as the main culprit. Consistently bad experiences could breed deeper-seated issues for brand trust and customer loyalty.
On a more day-to-day level, problems with your sales tax calculation engine can also stall your checkout. When evaluating a sales tax automation partner to add to your checkout, be sure to look at their uptime, their average response time, and their ability to handle volume spikes such as sales and marketing promotions, or busy shopping days like Black Friday.
The right technology ensures sales tax doesn’t become a hindrance and allows you to keep doing what you do best — serving your customers.
5. Maintain oversight of channel-based sales tax
Expanding into new sales channels is a common growth play. But it’s also another chance to make sales tax-related missteps.
For example, you hire a developer to move you over to an ERP like NetSuite. If you forget to tell that developer that you have complex sales tax collection requirements, then you may end up failing to collect sales tax for a period of time. Seriously – because sales tax is such a background, back-office task, it easily falls by the wayside in times of rapid growth.
To make things easy, you need a sales tax automation solution that can integrate with multiple eCommerce platforms, marketplaces, and cart solutions.
It’s time to think about sales tax management
Sales tax compliance is one of those administrative hassles that’s easy to overlook… until it becomes a problem.
That’s why we recommend automating your sales tax compliance so you can get back to doing what you do best: growing your SaaS business.
To learn more about TaxJar’s solution and how we can guide you down the road to compliance, check out these sales tax resources created for SaaS businesses like yours.
Mark Faggiano is the Founder and CEO of TaxJar, a 100% remote company and the leading sales tax technology solution for eCommerce merchants. Over the past 15 years, Mark has funneled his passion for SaaS to help companies move upmarket by solving complex problems with an intense focus on customer service, consumer education via content and scalable technology. At TaxJar, Mark raised the biggest Series A funding round in history for an all-remote company whose unique culture has garnered nine workplace awards, including Best Company Culture and four technology awards in 2019 alone. Mark was named 2019’s number one Small and Mid-Sized CEO by Comparably. A five-time entrepreneur, Mark previously co-founded FileLater, which became the web’s leading tax extension service before selling to Banks.com in 2010. Mark earned his B.A. at Boston College and MBA at the University of San Diego, CA.