How to create a sales tax schedule to conquer complexity and improve compliance

For SaaS companies, determining what part of their offerings are taxable in the US can be a big challenge. States vary widely in how they classify and tax SaaS – some view SaaS as a tangible product, others view it as a service, and some don't tax it at all. This means your sales tax schedule needs to account for all these variations to ensure accurate collection and remittance.

This article will walk through the importance of sales tax management and detail a step-by-step approach to building a sales tax schedule that keeps your SaaS business compliant. 

Navigating the complexities of SaaS sales tax in the US

Understanding sales tax for SaaS starts with the basics: a sales tax in the US is a percentage-based fee added to the purchase price of goods and services. Sales taxes are considered an indirect tax, meaning businesses collect it from customers and remit it to the appropriate tax authorities.

What makes this challenging for SaaS companies selling in the US is the lack of uniformity across states. Unlike traditional physical products, SaaS doesn't fit neatly into existing tax definitions. Is it a digital good? A service? The answer changes depending on which state you're dealing with.

There is no federal sales tax, and all 50 states can define SaaS for the purposes of taxing in their own way. That said, most states use some variation of these three categories for software products:

• Tangible software: Like boxed products sold at retailers (a software CD, for example)
• Downloaded software: Licensed programs installed directly on local devices
• Software accessed via the cloud: SaaS products accessed remotely via the internet

SaaS falls into the third category as most SaaS applications are cloud-based, meaning SaaS customers access their products remotely without having to download it to their devices. Note that while some SaaS companies offer apps that can be downloaded, they are best thought of as “companion” apps – just one vehicle for delivery of a service that is hosted and accessible via the cloud. 

Different states in the US vary in how they interpret and tax software accessed through the cloud.

Some states classify SaaS as “canned computer software” and tax it as tangible personal property, regardless of the form in which it is delivered to the customer – an approach that ignores the categories above.  

Some states like New York, California, and Texas have detailed rules specifically addressing digital services. 

Other states might offer broader exemptions for certain types of services or business uses. For example, if a state doesn't tax services at all, your SaaS product might be exempt.

But if a state categorizes SaaS as a “digital good” or “specified digital product,” you'll need to collect and remit sales tax according to their rates.

And then if all that isn’t complicated enough, there may also be local-level tax requirements that apply within a given state. According to the Tax Foundation, local sales taxes are levied in 38 states and in some cases, exceed the state sales tax. Figuring out where and how those taxes apply to SaaS only adds to the complexity. 

All this variation, and the penalties for non-compliance in how you collect and remit sales taxes to each taxing authority, underscores how critical it is to maintain an accurate sales tax schedule. 

Significance of SaaS sales tax management

Building an accurate sales tax schedule can help you conquer the complexities inherent in sales taxes to provide a solid foundation for your overall sales tax management. It’s a lot of work at first, but here’s what you stand to gain:  

• Better risk mitigation and compliance: Accurate tax collection and filing protects businesses from penalties, interest charges, and any legal issues. 
• Greater operational efficiency: A well-structured tax schedule helps finance leaders focus on strategic initiatives like strategic budgeting, forecasting, and financial planning rather than troubleshooting tax issues.
• Improved cash flow: Proper sales tax management prevents unexpected tax liabilities that can upset your cash flow and strain cash reserves. It also ensures that the company collects the right amount of tax from customers to avoid both over- and under-collection scenarios.
• Scalability and M&A readiness: A sales tax management system supports business growth across new markets and jurisdictions. During mergers or acquisitions, clean tax records and processes increase your company's valuation and simplify due diligence.
• Accuracy and audit readiness: Maintaining detailed tax records and documentation helps leaders sail through audits confidently. This preparedness can save time and resources when tax authorities come knocking.
• Investor confidence: Strong tax compliance increases investor’s trust in your company. This is extremely important during funding rounds or when preparing for an exit.

How to create a sales tax schedule

When creating a sales tax schedule, the US state-specific rules are the legal requirements that directly impact your compliance obligations. 

Here are eight steps to create a SaaS sales tax schedule. 

Step 1: Track customer locations

The first step is to track where your customers are located. This is most important since tax rates and rules vary by jurisdiction.

Step 2: Determine where you have an economic nexus

Identify where your business has established an economic nexus (often called the sales tax nexus), which is a connection that creates a tax obligation in a state other than your company’s “home” state. In the US, the economic nexus decides whether your out-of-state SaaS business must collect and remit sales tax in a given state. 

The economic nexus is typically triggered by exceeding thresholds for the total dollar amount of your sales in that state and/or the number of transactions. 

Step 3: Research tax rules by jurisdiction

The next step is to analyze each state's unique requirements for taxing SaaS. Here, it’s important to determine whether the state treats SaaS as a physical property or service and to understand the applicable tax rates in each jurisdiction. You also need to account for any local taxes that stack on top of state rates. 

When you consider that there are 50 states and a potentially huge number of local taxing authorities within each, the task of figuring all that out seems pretty daunting. 

Here are some ways you can make this step more manageable: 

• Start at the state level. In addition to providing the information you need for state sales taxes, many states’ department of revenue websites also provide information on jurisdictions that impose additional taxes. Some also provide online tools to search for local sales taxes that may be applicable to SaaS.  
• There are also several online platforms that provide US-wide tax lookup tools (some free and some paid). 
• And of course, you can also seek professional guidance to help you ensure you capture all the applicable sales taxes in this step. 

Step 4: Classify your offerings

In this step, you need to create clear categories for your products and services. This includes distinguishing between pure SaaS solutions, hybrid models that combine software with services, customized implementations, and bundled offerings that might include hardware or other software components.

This will help you more accurately determine how the taxes in each state and any local level taxes apply to your business.  

Step 5: Build your schedule

Finally, create a detailed document or spreadsheet that includes all critical information. This should include:
Jurisdiction names at both state and local levels, tax status (taxable vs. non-taxable), current tax rates, effective dates, special conditions (e.g. thresholds for determining economic nexus), exemptions, and documentation requirements.

Step 6: Maintain regular updates

Set a schedule to review and update your tax information regularly. This involves monitoring state legislation changes, tracking rate adjustments, updating nexus thresholds, and reviewing new interpretations of digital service taxation as they emerge.

Step 7: Document everything

Maintain detailed records of your entire sale tax management process including how you determine whether sale tax applies, rate change histories, exemption certificates, and the reasoning behind changes you make for compliance. 

Step 8: Implement automation

Consider implementing tax automation and financial reporting tools to streamline your processes. These tools can calculate rates in real-time, track jurisdictional changes, generate required reports, integrate with your billing and accounting systems, and maintain compliance documentation automatically.

Best practices for SaaS sales tax management to stay compliant 

Following the below best practices provide a strong foundation for tax compliance and financial management for SaaS companies. 

Stay ahead of tax laws

Tax rules for digital services change frequently. Set up reliable monitoring systems through financial planning tools or tax partners to track any changes.

Know your nexus requirements

Track where your tax obligations lie based on the economic nexus thresholds that trigger the obligation to collect and remit sales taxes in each state. If you use an automated system, set up alerts for when you approach nexus limits in new jurisdictions. If not, set up reminders to check this periodically.

Maintain a compliance calendar

Keeping a compliance calendar helps teams keep track of finding frequency, remittance schedules, exemption certificates, etc. It also helps you stay on track and prevent penalties and interest charges.

Automate sales tax management

Manual tax management is prone to errors. Integrate tax automation with your billing system to reduce risks.

Keep audit-ready records

Maintain clean documentation of transactions, rates, and exemption certificates. In addition to being an invaluable resource in the event of an audit, your documentation can help you in doing your due diligence, strategic planning, and sales forecasting.

Plan for global compliance 

Build your tax system to handle both domestic and international requirements from the start. Having scalable processes saves future headaches.

Integrate your sales tax schedule into your overall financial planning

A sales tax schedule is just one piece of your company's broader financial documentation. Just as you maintain other supporting schedules like your debt schedule for tracking loan obligations and fixed asset and CapEx schedules to support tracking of existing and planned investments, your sales tax schedule should be integrated into your overall financial planning framework.

Leveraging technology can make sales tax management easier

While some companies manage sales tax schedules using spreadsheets, the complexity of sales tax management for SaaS, along with the potential penalties for non-compliance, make this extremely risky. 

Manual tracking across multiple jurisdictions, frequent rate changes, and various exemptions–a small error here or there–can lead to penalties and compliance issues. 

Modern FP&A software allows you to seamlessly manage your schedules on one hand and automate your financial planning on the other.

Drivetrain is a comprehensive financial planning and analysis (FP&A) software that helps SaaS companies manage compliance, tax management, and streamline financial planning. It offers a robust set of features that help leaders:

• Consolidate data across all revenue streams by integrating with different systems.
• Automate tax calculations and updates supporting schedules in real-time.
• Streamline financial reporting for tax compliance.
• Monitor tax obligations through dynamic dashboards.
• Collaborate with different teams for tax planning.
• Track key KPIs for tax impact on business performance.

Whether you're scaling your SaaS business, planning international expansion, or optimizing your tax operations, having modern financial planning software makes all the difference. 

‍Learn more about how Drivetrain can transform your financial planning and management by automating tax management.