Sales tax can be complicated for software-as-a-service (SaaS) businesses. Software services can be delivered globally and typically must contend with several different tax environments, each of which has different rules about how to tax digital goods and services. Some areas treat SaaS as a product while others treat it as a service, and tax obligations are made even more complicated by the swift evolution of tax laws to keep pace with the digital economy. As of March 2025, SaaS services are taxable in 25 US states.

Below, we’ll explain how SaaS businesses should approach their sales tax obligations.

What’s in this article?

• Types of taxes SaaS businesses need to think about
  
• How sales tax works with SaaS products
  
• Challenges associated with sales tax for SaaS
  
• How to calculate sales tax as a SaaS business
  
• Best practices for working strategically with sales tax in SaaS
  

Types of taxes SaaS businesses need to think about

SaaS businesses have more tax obligations than sales tax alone. Here are the different types of taxes SaaS businesses need to think about:

• Sales tax: Sales tax can be challenging for SaaS businesses because the rules vary by state and country. Whether a SaaS product is taxable depends on how each jurisdiction categorizes digital services.

• Income tax: Both federal and state income taxes apply to SaaS companies. These companies need to know how their incomes are taxed in each jurisdiction where they operate. This involves managing different corporate tax rates and any potential deductions and credits.

• Value-added tax (VAT): VAT is relevant for SaaS companies that do business internationally, especially in the European Union. VAT is a consumption tax that’s added to the value at each stage of production or distribution.

• Withholding tax: This tax might apply to international transactions where a SaaS business pays for services from overseas. Some jurisdictions require companies to withhold part of the payment as tax, which the service provider can often offset against its own tax liabilities.

• Property tax: Although this tax is not directly related to the services SaaS businesses provide, they might need to pay property tax on physical assets they own, such as servers and office equipment.

• Payroll tax: SaaS businesses with employees must also manage payroll taxes. This includes withholding income tax and paying employer contributions to Social Security, Medicare, and possibly other employment-related taxes depending on the location.

How sales tax works with SaaS products

Sales tax on SaaS products is uniquely complicated due to the nature of the product and changes in the taxation of digital goods. Here’s how sales tax works when it comes to SaaS products:

• Nexus: SaaS companies can establish a sales tax nexus (the connection between a business and a state that requires the business to collect and remit sales tax) through factors beyond physical presence. Activities such as remote software access can cause companies to pass economic thresholds for nexus (e.g., a certain amount of sales or transactions within a state).

• Taxability of digital goods: The taxability of SaaS varies between jurisdictions. Some states treat SaaS as a taxable service, while others do not. This requires SaaS providers to continually monitor and update their sales tax processes according to the state laws where their customers are located.

• Sourcing rules: Determining where the sale of a SaaS product is taxed involves sourcing rules. For SaaS businesses, this can be particularly challenging as the service can be accessed from multiple locations. States might use origin-based sourcing (based on the location of the seller) or destination-based sourcing (based on the location of the buyer). This impacts how tax is calculated for each sale.

• Exemptions and exceptions: SaaS products might qualify for exemptions based on the type of customer (e.g., nonprofit organizations, educational institutions) or the purpose of the software (e.g., B2B transactions that qualify as wholesale sales). Businesses must understand the specific criteria in each jurisdiction to apply these exemptions correctly.

Challenges associated with sales tax for SaaS

Here are some of the main challenges SaaS businesses face in managing sales tax:

• Regulations: The tax laws that govern digital goods and services such as SaaS are continually changing. Many jurisdictions are still adapting their tax codes to account for the digital economy, leading to frequent changes in tax policies. Keeping track of these changes requires substantial effort and resources.

• Taxability rules: Each state, and sometimes each local jurisdiction, can have different rules regarding the taxability of SaaS. Some treat it as a taxable service, while others exempt digital goods from sales tax. This means SaaS providers have to assess and implement different tax collection strategies based on a customer’s location.

• Automation: Implementing automated solutions to manage tax calculations, collections, and remittance can be challenging and costly. But failing to use these solutions can result in errors and noncompliance. And those can lead to audits, penalties, and damaged relationships with customers.

• International sales tax and VAT: For SaaS companies that operate internationally, addressing the VAT systems and sales tax laws of different countries adds another layer of complexity. To comply with international tax regulations, they must learn the rules of multiple tax jurisdictions and potentially register and file in several countries.

• Pricing: Including or excluding sales tax in the listed price can impact the market competitiveness of a SaaS product. Businesses must balance compliance with pricing tactics that meet customer expectations and regulatory requirements.

How to calculate sales tax as a SaaS business

Here’s how to calculate sales tax as a SaaS business:

• Determine nexus: First, identify where you have a tax nexus. This includes any state or country where your business has a substantial presence, which could be established through physical locations, employees, affiliates, or economic activity (e.g., sales thresholds).

• Understand taxability: Research the taxability of SaaS in each jurisdiction where you have nexus. Determine whether your service is taxable and how it’s classified, as this affects the applicable tax rate.

• Register for sales tax permits: Once you establish nexus and taxability, register for sales tax permits in those jurisdictions. This is a legal requirement before you start collecting sales tax from your customers.

• Implement tax calculation tools: Use automated tax software that integrates with your billing system. This software can dynamically calculate the correct tax rate based on your customer’s location and the applicable laws, adjusting for any changes in tax rates or rules.

• Set up sourcing rules: Decide whether your tax calculation will follow origin-based (taxed where the business is located) or destination-based (taxed where the customer is located) sourcing. Most US states use destination-based sourcing for SaaS, but this can vary.

• Collect customer location data: Collect and verify customer location information for tax calculation. This includes the full address and, in the case of international sales, the country of residence.

• Calculate the tax: Using the correct tax rate and sourcing rules, calculate the tax for each transaction. Ensure that any exemptions (e.g., for nonprofit organizations) are accurately applied based on customer status and documentation.

• Send detailed invoices: Clearly state the sales tax on the customer’s invoice and show the breakdown between the net price, tax rate, and total cost. Transparency in invoicing helps maintain trust and compliance.

• Remit and report taxes: Regularly remit the collected taxes to the appropriate tax authorities before the deadline. This typically involves filing periodic tax returns that detail the sales tax collected and remitted.

• Maintain records: Keep detailed records of sales, tax calculations, customer exemptions, and remittances. Good recordkeeping will help you handle audits and comply with tax regulations.

Best practices for working strategically with sales tax in SaaS

Here are some best practices around sales tax that SaaS businesses should keep in mind:

• Stay proactive with nexus obligations: Regularly review and update your nexus footprint as your business grows or changes. Expansion into new territories, whether through physical presence or economic activity, can alter your tax obligations.

• Use automated tax compliance software: Invest in reliable sales tax automation software that integrates with your billing system. This technology can accurately calculate tax rates based on customer location, apply the correct rules for exemptions, and update in real time to reflect changes in tax laws across jurisdictions.

• Educate your team: Ensure that your finance, sales, and IT teams understand the implications of sales tax on business operations. Regular training sessions on tax compliance and updates in legislation can help prevent costly errors and create cohesive practices across departments.

• Maintain accurate customer data: Accurate tax calculations rely on correct customer location information. Implement strict controls for collecting and verifying customer addresses and use geolocation services when applicable to confirm the data’s accuracy.

• Conduct regular audits and reviews: Conduct regular internal or external audits of your sales tax processes to identify any potential issues or inefficiencies. Regular reviews can help catch errors early and allow you to adjust tactics in a timely manner.

• Hire legal and tax experts: Consulting tax experts or legal advisers can be helpful when you handle complicated tax laws in quickly developing fields such as digital services. These professionals can offer up-to-date advice on compliance, help with tax planning, and provide support during audits.

• Communicate with customers: Clearly communicate tax charges on invoices and during the checkout process. Transparency about how taxes are calculated and applied can build trust and minimize confusion and potential disputes.

• Plan for international expansion: If you plan to serve customers globally, prepare to handle different tax regulations in different countries, especially concerning VAT and goods and services tax (GST). International tax compliance can be challenging so consider using specialized tax professionals and software to manage these obligations.

• Refine for tax savings: Look for opportunities to reduce tax liabilities. These might include exemptions, tax credits, or incentive programs for technology businesses.

• Stay agile: Tax regulations are subject to frequent changes, especially around digital services. Stay agile by keeping your tax compliance strategy adaptable to new laws and regulations.