SaaS sales tax: nexus thresholds and which states tax it

A SaaS company owes sales tax in a state only when two things are true: it has nexus there, and that state taxes SaaS. New York and Texas tax SaaS and California does not, and each of the three sets a $500,000 threshold before a seller with no physical presence must register and collect.

Since the Supreme Court's 2018 decision in South Dakota v. Wayfair, a state can require collection from a seller with no office or employees in it, based on sales alone. This guide covers how nexus works after Wayfair, how New York, Texas and California treat SaaS, a worked example across those three states, what to do once you cross a threshold, and how the tax sits in your books.

Do SaaS companies have to charge sales tax

Sometimes. Sales tax is set state by state, so a SaaS company asks two questions for each state where it has customers: does it have nexus there, and does that state tax SaaS. It collects only where both answers are yes. A company with customers in many states can owe in some and none in others.

The two questions are independent. A state can tax SaaS while you are still under its threshold, so you collect nothing yet. Or you can be far over a state's threshold for a product it does not tax, so you collect nothing at all. Physical presence still counts on its own: an office or an employee working in a state can create nexus there before any sales threshold is reached.

The answers change as you grow. A company that sold to ten customers in its home state at seed can have taxable nexus in several states by Series A without having opened a single office, because every new customer counts toward a threshold somewhere.

What sales tax nexus means for a SaaS company after Wayfair

Nexus is the connection to a state that lets it make you collect its tax. Before 2018 that required physical presence. In South Dakota v. Wayfair, decided June 21, 2018, the Supreme Court held the physical presence rule "unsound and incorrect", and states began setting thresholds based on sales into the state.

The law the Court upheld covered sellers that delivered more than $100,000 of goods or services into South Dakota a year, or made 200 or more separate transactions there (South Dakota v. Wayfair, 585 U.S. 162). Other states then wrote their own rules, and they differ in three ways that matter:

• The amount. South Dakota's law used $100,000. New York, Texas and California use $500,000.
• What counts. Texas counts all revenue from sales into the state, taxable or not. California and New York count sales of tangible personal property, and New York treats software as tangible personal property.
• The period. New York looks back four sales tax quarters, Texas twelve calendar months, and California the current or preceding calendar year.

Is SaaS taxable in New York, Texas and California

New York taxes SaaS as prewritten software, wherever the code runs. Texas taxes it as a data processing service, on 80% of the charge. California generally does not tax it, because the customer receives no tangible personal property. Those three rules show the range: taxed in full, taxed in part, and not taxed.

New York sources the sale to where the customer uses the software. If a customer's users sit both inside and outside New York, the seller collects tax on the share of the charge for the users in New York.

Texas applies the 6.25% state rate, plus any local tax, to the taxable part (Publication 94-127). Only the part of the service used in Texas is taxable, and a customer with locations in several states may give you an exemption certificate and account for the Texas tax itself.

California's Regulation 1502 says a prewritten program transferred by remote telecommunication, with no storage media, is not a taxable sale. It also says that charges for the use of a computer accessed by remote telecommunication are not taxable. A product that ships hardware or physical media changes the answer.

Sales tax nexus thresholds in New York, Texas and California

All three states use $500,000, but they count it differently. New York needs both more than $500,000 and more than 100 sales over four quarters. Texas counts all Texas revenue over twelve calendar months. California counts sales of tangible personal property in the current or preceding calendar year.

The New York test is from Registration requirement for businesses with no physical presence in New York State. The Texas safe harbor is from the Comptroller's Remote Sellers page, and the California rule is from CDTFA's Wayfair guidance on Revenue and Taxation Code section 6203.

New York's transaction count matters for a SaaS company with large contracts. Counted one sale per invoice, a seller with $2,000,000 of New York sales spread over 40 enterprise invoices has not made more than 100 sales, so it is under the test. How monthly invoices to one customer are counted is a question for your adviser.

A worked example: one SaaS company, three states

A startup has no office or employees outside Delaware, where it is incorporated. Over the last four quarters it invoiced customers in three states. The question for each is whether it must register and collect, and what a crossing would cost.

New York is the one that needs action now: $620,000 is over $500,000 and 140 invoices are over 100. Texas is close. If next year's Texas sales reach $600,000, the taxable part is 80% of that, $480,000, and the 6.25% state tax on it is $30,000 a year before local tax. California's $900,000 does not count toward its test, because the startup sells no tangible personal property.

Sales tax is charged to the customer on the invoice. Adding it to invoices months after they were paid is hard, which is why the date you cross a threshold matters more than the rate.

What to do when you cross a sales tax threshold

Register with the state before your first taxable invoice after the crossing, then add the tax to invoices and file returns. Texas gives remote sellers until the first day of the fourth month after the month they exceed $500,000. New York expects you to check after every quarter, and to register as soon as the four quarters before cross both tests.

The Texas Comptroller's own example: if Texas revenue for July 1, 2021 through June 30, 2022 exceeds the safe harbor, the seller must get a permit by October 1, 2022 (Remote Sellers). New York's guidance says to review your New York sales after the end of each sales tax quarter.

Once registered, each invoice into that state carries the tax for the customer's location, and you file on the schedule the state assigns. Your billing system needs the customer's address, and for New York the location of their users, on every account. Rules on what is taxable, and on exemption certificates, differ by state, so a sales tax adviser is worth the fee before you register in your first state.

How sales tax shows up in your books

Sales tax you collect is the state's money, held until you file. It goes to a sales tax payable account on the balance sheet when you invoice, and leaves when you pay the state. Revenue is the subscription price without the tax, so the tax never inflates ARR or revenue.

On a $12,000 annual prepay to a New York customer, the invoice total includes the tax, but only the $12,000 goes to deferred revenue and then to revenue month by month. The tax goes straight to the liability. Keeping it there also means the ARR you report to investors is the same number before and after you register in a state.

The other books task is tracking. Every threshold above is measured in sales and invoice counts by state, over a rolling period, which is a report from your ledger rather than a guess. LedgerIt keeps each invoice with its customer, so revenue by state for the last four quarters comes from the books you already close every month.

What to do this month

• List revenue and invoice counts by state for the last four quarters and the last twelve months.
• Compare each state with its threshold, and note what that state counts.
• Check whether each state taxes SaaS, starting with New York and Texas.
• Collect customer addresses, and for New York customers, where their users sit.
• Register before the next invoice in any state you have crossed, and set up a sales tax payable account.
• Re-check every quarter, because the lookback windows roll forward.