Why Sales Tax Compliance Matters for Growing SaaS Companies

As a growing SaaS company, there is a lot to think about in a day: How is my ARR doing? Are we delighting our customers? Are we doing right by our people? What does our next round of funding look like?

When do you have time to think about preparing your company for the future? And, when you do, do you even think about sale tax compliance? Here’s why you should. 

States across the U.S. vary on how they handle sales tax and SaaS. It can be confusing to understand how and where you should charge sales tax. As you scale up, it’s essential to ensure that your sales tax management process is accurate and automated, so you don’t run into compliance issues in the future. 

Let’s explore a few more ways in which sales tax compliance could impact your growing business.

Reduce the risk of audits (and possible back taxes)

Non-compliance (failing to accurately prepare and file sales and use tax returns) can heighten your risk of both an intensive sales tax audit and paying back taxes. The most effective way to reduce your risk of an audit is to file your tax returns on time and accurately. 

Sales tax audits are typically out of your control — sooner or later, you’ll likely be audited. It’s part of doing business! States are consistently looking for ways to generate more tax revenue, and a fast-growing company (or industry) can provide excellent opportunities. As a SaaS company, you could even get flagged for an audit because of quick growth.

But even though you can’t necessarily prevent an audit, you can take steps to reduce your overall risk of an audit and paying back taxes unnecessarily. 

You have two options to ensure compliance: 1) Go through the eight-step process of sales tax compliance, including gathering the sales tax data, reconciling the data, filing the tax return, and paying what you owe. Or 2) File sales tax returns online through a sales tax solution that tells you when, where, and what you need to remit. While the first option is more tedious, both will help reduce the risk of an audit and, even if you are selected, ensure that you aren’t penalized for non-compliance.

SaaS company Basecamp discovered the need for these steps firsthand. “Our first introduction to sales tax was dealing with it as a liability,” CTO and Co-founder David Heinemeier Hansson says. “We discovered we should have been collecting sales tax but we weren’t, so we had a number of liabilities in different states that needed to be cleaned up.” Basecamp had to pay millions in back taxes. The company now files automatically through a sales tax tool to avoid repeating the same mistakes. 

Better follow economic nexus laws 

Once limited to physical presence, nexus now exists because of your economic activity in a particular state. For SaaS companies, this means you could be over economic nexus thresholds (i.e., the dollar amount or a number of transactions required by states to collect and remit sales tax) without even realizing it. This lack of compliance with economic nexus laws could cost you in back taxes and penalties. 

As a SaaS company, you can meet the economic nexus threshold by selling a certain number of software subscriptions in a state to only a handful of customers. These thresholds vary by state, but economic nexus thresholds essentially mean “even if you do not have a physical presence in a state, if you pass a state’s economic threshold for total revenue or number of transactions in that state, you’re legally obligated to collect and remit sales tax to that state.”

Considering that SaaS companies typically charge a monthly subscription amount, one customer can create 12 transactions. In short, you can exceed the transaction threshold with only 17 customers in a state. 

Stay proactive with economic nexus law thresholds to collect and remit sales tax in the right areas. Research economic nexus nuances by state for SaaS companies. For example, sales and use tax does not apply to SaaS in California. But in Texas, 80% of a SaaS company’s revenue is subject to sales tax. 

A sales tax professional can also help you determine the economic nexus thresholds in different states with your SaaS product. By understanding what constitutes sales tax compliance by state, you decrease tax liability as you scale into new markets (e.g., you’re using PPC [pay-per-click] ads that cause users to purchase in different states). An automated sales tax tool can also tell you if you meet economic nexus thresholds in any state. 

Reduce time-consuming and costly mistakes

If you have to manually calculate, collect, and report sales tax for your SaaS product, you not only risk collecting the wrong amount of state and local sales tax, but you also risk making mistakes on your sales tax returns. You would then have to spend hours trying to remedy the errors. These errors can also be expensive if they require you to pay back taxes.

Say that you accidentally calculate and collect the wrong amount of sales tax on your SaaS service. You’d have to manually calculate and pay back the difference in sales tax. Even if it’s a small amount per sale, that’s still a percentage of profits lost. Also, as you manually collect sales tax and fill out returns, you could miss the deadlines for filing returns or fail to account for the right frequency for each state. 

Save time and avoid mistakes with automated sales tax collection and filings. Using a sales tax automation tool means that your sales tax rates are automatically calculated and collected, and sales returns are automatically prepared and filed. 

As an example, the TaxJar API gives you the ability to assign a product tax code to your SaaS services. The API then automatically charges your customers in any state the right amount of sales tax depending on that state’s applicable SaaS sales tax laws, so there’s no guesswork involved with rates. Your tax payments are also made for you with TaxJar’s AutoFile. 

KiwiCo, a subscription-based educational toy company, discovered the benefits of automated filing. The company turned to sales tax automation to stay current and automate sales tax compliance. “Without AutoFile we would have needed multiple people to manually process sales tax,” says COO Bill Onderdonk. “But with AutoFile, we’ve scaled to doing taxes in 40+ states.”

More likely SaaS financing and valuation

As a growing SaaS company, you’re likely in the market for funding. Investors check both your growth plans and how you’ve managed your company so far. From a legal perspective, SaaS investors want to know that key tax considerations are taken into account. 

The discovery of the lack of sales tax compliance can seriously impact your valuation and an investor’s choice to invest in your company (or even pull back funds). 

SaaS companies funded by founders and early revenue grow an average of 28% per year while companies that raise funding grow 43-50% annually. Having investors trust your company’s management and financial performance enough to provide funding can impact your SaaS company’s success. 

Conduct an internal sales tax audit to assess your compliance (before the state requires one) — here’s a SaaS sales tax checklist to help you get started. Look for states where you have economic nexus. Ensure that you’re registered in that state for a sales tax permit. 

Designate a person within your company to track economic nexus activity and determine how often you will need to file for each state (monthly, quarterly, annually, semi-annually). Also, ensure that you have clean tax returns to help investors with their due diligence.

Ensure that your SaaS sales tax operations are compliant

Sales tax compliance for growing SaaS companies can be a serious headache because each state has its own sales tax laws. But adhering to these laws isn’t optional — it’s essential for the success and safety of your business. 

Ensure that you’re preparing and filing sales and use tax returns correctly across states. You can do this manually or use a sales tax automation tool like TaxJar that will complete the process for you.

Published on September 14, 2020

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