With software as service companies growing more rapidly every year, it’s vital to keep a keen eye on the taxation process so that your business can flourish! In this article, we’ll review how software-as-service can differ from other subscription-based platforms, the taxation laws in various different areas in the U.S., and different taxation laws for overseas businesses in both a B2B and B2C space.
What is Financial SaaS?
Software-as-a-service, better known as SaaS is a software program that follows a licensing model on a subscription basis for consumers. SaaS is considered to be part of cloud computing, along with infrastructure as a service (IaaS), platform as a service (PaaS), desktop as a service (DaaS), managed software as a service (MSaaS), mobile backend as a service (MBaaS), and other variations of this like data center as a service (DCaaS) and integration platform as a service (iPaaS). The most prominent examples would be services like Microsoft Office, or Google products like Google Docs and Google Sheets. These softwares are available to everyone, even without a subscription. However, some products like Adobe, charge individuals on a monthly or yearly subscription basis for their line of products.
When it comes to software-as-service the concept is fairly similar. Typically, the consumer or individual pays for a monthly or annual subscription to where the firm or consumer can use their product on a consistent basis. Subscription companies often work off a tier system, especially if they have multiple tools available for different areas of financial analytics. Take for instance Adobe Quickbooks. If you’re an ecommerce store using Quickbooks you may not be interested in the 1099 self-employment tax calculator but more interested in their ecommerce growth tools and viewing your gross profits versus your monthly operation costs.
Service-based software subscription companies have been around for several years, especially due to growth within the digital market and the growth of ecommerce. As this field grows so do the new taxation rules and regulations that govern these models. In this article, we’ll review different software-as-service products, how they’re taxed in different locations, and the difference between business-to-business (B2B) and business-to-consumer (B2C) taxation laws. Taxation on SaaS is constantly developing, and it can be hard to keep track as this company model grows in popularity every passing year. Here are a few things to keep in mind, if you and your cofounder are developing a subscription-based digital model.
How Does SaaS Work?
Software as service products is incredibly diverse due to the nature and flexibility of the services provided. That being said there’s a wide range of options to choose from, whether you’re using software to code and come in a wide range of options. Whether you’re using software to code, photoshop, or keep track of your business, all of those software products are most likely subscription-based services. But because of SaaS products’ wide range of options and being completely online, it can be harder to decide what’s taxable and what’s not as some states argue that because the product is not tangible, it should not be taxable.
It can be difficult to find out if your SaaS product is taxable on your own, but by following this article, you can have at least a general idea of what to watch out for and research as you help your company develop.
B2B and B2C
B2B and B2C both fall under software-as-a-service, but it’s crucial to understand the difference between the two. The key to remembering the difference between these two types of models is who your target market is and if it’s other vendors or consumers. B2B, also known as business to business, is when your company focuses on selling to other businesses that may find your software useful to them. B2C, or business to customer, is when your software is aimed toward individuals, not on a large group basis like a B2B would be. Of course, not every business model is this black and white. SaaS products like Microsoft Office 360, are available for purchase either on an individual level or for an entire business, depending on your needs. Some services are even bought by whole universities for their student population, such as Adobe Photoshop. Not every product will fit into these particular niches, but as your business is growing, it can be important to keep in mind who you’re aiming to sell to, or even if you exclusively want to stay to one business model for tax purposes. You may also want to have both a business-to-business subscription platform and one for individuals, to maximize your annual profit. Intrepid recommends talking to a financial professional to allow yourself to scale both adequately and consistently over time.
As a business, it can be important to understand where your company lies for tax purposes. A B2B company may have stricter tax rules, depending on the state since you are selling to a company. B2C software, in some cases, has laxer tax laws as you are selling on an individual basis, but it’s important to check the laws in the state your business is located in, as the rules for SaaS sales tax are constantly changing as it’s a new and developing product in the states. Some states can have stricter laws about how they tax SaaS B2C companies, as it is not taxed federally.
How SaaS Sales Taxes Change By Location
Saas sales taxes change completely depending on location. Whether you’re selling internationally, or even in different states, it’s important to keep in mind how these sales taxes change throughout. While it’s important to keep track of not only United States-based taxes, it’s also important to keep track of the international taxes your customers are located in.
The taxation process can be even more cumbersome if you’re selling products internationally. When your customers are based outside of the United States, you will need to pay taxes to both the US and the country they’re from. Since each country has its taxation laws, our Intrepid specialists recommend looking into each country’s taxation laws before your firm starts doing business there.
Researching each country’s taxes is important. For example, the European Commission considers software services to be taxable using VAT. VAT stands for value-added tax, and is the idea that anything bought or sold within Europe is potentially taxable. This means that these software services are considered taxable in European countries. If your customers are located anywhere inside the EU, you will owe taxes in those locations
It can be harder to figure out when a SaaS company needs to be taxed on their state taxes. Each state has a different argument on whether software is a taxable object. States like Alabama consider software a tangible object for people to own, and thus should be taxed. Virginia, however, rules that because software services are available widely online and accessed through the Internet, they shouldn’t be considered taxable. State laws and taxes argue completely different rulings depending on each state. Below is a brief outline of what the taxation rule is for each state currently, but keep in mind that states can change these laws or can get extremely specific. It’s important to do your research on the laws beforehand or to talk to a SaaS financial specialist before making a final decision
- States where Saas is Taxable: Alabama, Arizona, Hawaii, Iowa, Maine, New Mexico, New York, Pennsylvania, Rhode Island, South Carolina, South Dakota, Tennessee, Texas, Utah, Washington, Washington D.C., West Virginia
- States where SaaS is not Taxable: Arkansas, California, Colorado, Florida, Georgia, Idaho, Illinois, Indiana, Kansas, Kentucky, Louisiana, Maine, Maryland, Michigan, Minnesota, Mississippi, Missouri, Nebraska, Nevada, New Jersey, North Carolina, North Dakota, Oklahoma, Vermont, Virginia, Wisconsin, and Wyoming
Preparing a SaaS Company for Taxes
When running a SaaS company, it’s important to play on the side of caution when it comes to taxes. It’s important to do thorough research on each state, if you’re considering selling internationally, and who your consumer base is. All of these are essential in finding out if your company is eligible to be taxed or not. Be sure to check in with your accountant or trusted tax advisor before making big decisions. If you’re uneasy about preparing your firm for tax season, Intrepid’s financial specialists are here to help — specifically for software-as-service-based companies. Contact one of our specialists today to learn more about how we can aid you in your business growth.