Making Sense of The Cloud, SaaS and State Tax

IMG_0129One of the hottest areas in the sales tax arena right now is the taxability of cloud-computing, cloud-based services, etc., collectively often referred to as Software-as-a-Service (or “SaaS”).  The very moniker alone is enough to start the state tax conversation down an interesting path.

The Basics

When we work with clients to determine how something should be taxed, we start with a few basic premises and then work from there.

Premise #1:  The taxpayer must have taxable presence (or “nexus”) with a state before the state can require the company to collect and remit sales/use taxes.  Nexus is created in a variety of ways, but it still refers to a physical presence, including such things as having employees in the state, third party contractors acting on the company’s behalf in the state, owning property (such as inventory) in the state, and owning or leasing office space in the state.

Premise #2:  Once nexus is established, in general, the sale of tangible personal property by a retailer to a customer in a given state is generally taxable.  We start there, and then review the transaction to see if there are any exemptions that would cause the sale of the property to not be taxable.  Exemptions may fall under categories such as the nature of the product being sold (food, certain medical products, etc.), the purchaser of the property (the U.S. Government), and the use of the product (in manufacturing or for resale), to name a few.

Premise #3:  As states are becoming more aggressive and seek to broaden their tax base, we also look to whether, after nexus has been established, the taxpayer is selling any taxable services in the state.  For services, we generally start with the assumption that services are exempt unless specifically enumerated as taxable.  Many services are straightforward and are clearly either taxable or not.  However, services such as “data processing”, and “information services” are some of the interesting “catch-all” services now considered taxable by some states.

 The Complications

As we think about the taxability of SaaS, we must go through those various steps in the analysis. The nexus question may (or may not) be clear.  But what about the cloud-based services themselves?  Are we selling software (it’s in the abbreviation after all – “Software-as-a-Service”)?  If so, how does a particular state tax software?  Is it tangible?  In most states, pre-written software is considered to be tangible personal property when delivered on a tangible medium, such as a disk.  Simple enough, but honestly, when was the last time you bought software on a disk?  In many states, if the software is downloaded electronically it is not considered tangible and is exempt.  But in others, prewritten software is taxable no matter how it is delivered.   So, assuming that a SaaS platform is considered to be prewritten software, there are already variations in how states might tax it.   But what if it’s not software, but instead is a service?  What kind of service?  Does it fall under a category like data processing or information services?  Maybe! Maybe not.  It depends on exactly what it is, and how the state might interpret it.


In Silicon Valley, and across the country, companies are developing new cloud-based revenue streams regularly, and the state tax laws simply can’t keep up.  In fact, many states have not officially expressed an opinion on cloud-computing at all, opting to handle each case as it comes.  If you work for a company that is trying to do the right thing and be a good corporate citizen, this approach from the states can be especially frustrating.  Similarly, if you work for a public company that needs to disclose filing positions or exposure areas, it can be difficult to reach a concrete conclusion.  Much of the state sales taxability is still in the gray area at the moment, and will likely continue to be for some time.

The Documentation

As we work with clients, we recommend that they work with a firm such as ours to analyze and document their situation as accurately as possible within the current guidance available on a state-by-state basis (starting with the company’s largest states).  Start with nexus, and then review the state’s position on taxability of software AND services and determine where the revenue item most properly falls.  The 80/20 rule often comes into play so it’s rare for a company to need a true 50 state tax study.  Even for larger companies, we can often get to 80% of the exposure areas by looking at 20 or fewer states.  And for smaller companies, it is often 10 or fewer states.  As with almost everything we do for clients, documentation is key.  It’s important to be able to demonstrate why a position was taken and the existing authority for taking it.

Finally, we run into several situations where companies want the quick answer – in a chart!  Charts are great, but SaaS is not a “one-size fits all” product, so the answers from the quickie charts provided by software products are often incomplete or may not truly address the company’s specific needs.  So we advise clients to tread lightly if someone suggests just pushing a button to create a chart.  There is a fair amount of interpretation involved in this question, and I’m not sure that even a cloud-based, SaaS providing, research tool has all the answers about its own revenue model at the click of a button!

Stay tuned for further updates on this topic. Or to schedule a free consultation about your cloud-computing or SaaS company state tax issue, please contact us at




2 thoughts on “Making Sense of The Cloud, SaaS and State Tax

  1. Pingback: Understanding Voluntary Disclosure | Miles Consulting Group

  2. Pingback: [State Tax Series] SaaS Companies & Multi-State Tax Issues | Miles Consulting Group

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