Sales Taxes for SaaS – Christine Martin Avalara

What sales taxes do SaaS companies have to pay in the US?

Steve Keifer:
The primary audience that watches this podcast is early stage companies. A lot of them are venture backed, some of them are bootstraped, but they’re primarily in the SaaS, cloud, fintech, AI, DTC, and subscription space. Some of the companies have their arms around sales taxes, but a lot of others do not. Many early-stage companies don’t even necessarily have a finance department.  Could you start by giving a general overview of sales taxes and how they apply to SaaS companies?

Christine Martin:
Here in the United States, we have this concept of nexus. And it used to be years ago that you had to have a physical presence (to be taxed). For software companies that are selling online, where’s your physical presence? Probably just an office, right? Retail stores was really obvious. If you had a retail store, you had a physical presence. Well, the state of South Dakota sent an assessment out to Wayfair, an online retailer of home goods, right? And said, hey you’ve created a presence for us in your state it may not be physical but we now want you to pay taxes here.

That South Dakota versus Wayfair case made it all the way up to the Supreme Court and the Supreme Court said economic nexus is a thing you don’t have to have a physical presence anymore just having this economic presence. Well what’s economic presence? Every state passed a law around economic nexus in their state and it would be absolutely silly if every state was the same. I wouldn’t have had a job for as long as I have. Some states say it’s based on the number of transactions. Others say it’s based on their total income. Others look at a combination of both. And now more and more people are having to become taxpayers.

People that obviously had stores, they were becoming taxpayers, but now insert all of these online sales and now I’ve now got to charge tax and understand the taxability in more states. I never had to before because I didn’t have a presence, but now how is clothing taxed in New York and in Washington and Pennsylvania and Texas? That’s an awful lot for people to manage. And that’s really where Avalara comes in because one, how the heck do people know when they’ve reached economic nexus. That’s a lot of analysis of a lot of data every single month. They’re doing other things. They’re not worrying about this economic nexus thing. But then they also have to understand how their products are taxed.

Product changes quicker than tax law. Tax law is always pretty old. They’re late to the game on an awful lot of things. So all of these concepts of e-commerce and marketplaces changed a lot quicker than this tax law. So people that are selling software online, how the heck do they know when they’re required to charge tax in another state? That’s not what they do, especially for people that don’t have a finance department like you’re talking about.

What are the risks of non-payment of sales taxes on SaaS?

Steve Keifer:
What happens if you don’t pay sales taxes on SaaS transactions? Does Johnny Law show up at the door? Does somebody show up with an invoice and demand collection? Are you restricted on your ability to do business in the state or raise capital or anything? What’s the risk?

Christine Martin:
There are so many risks. I actually spoke to a customer, a prospect, probably about a month ago, where they hadn’t been collecting tax anywhere, and somebody showed up at their door and said, we know you’re doing business in the state, but we don’t have you registered as a taxpayer and they started an audit. And if you never ever file a tax return, the statute of limitations stays open forever. The state of Alabama could have gone back 20 years since the business started.

Let’s talk about the funding piece, because this is really prime in the categories of folks that we’re talking about, is these companies that are doing due diligence, private equity firms, venture capital firms, are doing some due diligence, and they’re getting pretty smart about this sales tax stuff. And they may say, you guys aren’t billing sales tax. Why aren’t you? And then maybe as part of this deal, they’re gonna hold back some funds until you take care of it, or they’re just not gonna fund you because you haven’t taken care of this tax liability. And what’s interesting about all of this sales tax piece is if you’ve collected it and you don’t report it, corporate officers are held liable, personally liable.

Steve Keifer:
I hadn’t thought about that scenario, but if you’re just pocketing it and collecting it. Yeah. And I think the investor aspect is something a lot of folks don’t necessarily think about either, but yeah, the level of diligence that these VC and growth equity and private equity firms are doing these days is mind boggling. I can easily see that becoming an issue.

Christine Martin:
There was a conversation I had last week with somebody that was supposed to close and they had a whole bunch of tax obligation and the private equity firm said, you got to take care of that before we buy you or before we invest in you. And so they were scrambling. They’re like, how can we get this done in five days? It’s a little hard to do in five days, but they were pushing hard to get it closed. But that firm said, “No, you guys got to take care of this.” We’re not going to jump into this with a whole liability out there.

How do you get started paying sales taxes on SaaS?

Steve Keifer:
If someone hasn’t paid and hasn’t been collecting, how do they get their arms around this problem? How do they know where they may or may not have nexus? How do they just get a ballpark size of what their obligation on sales taxes is? Is there an easy way to get started?

Christine Martin:
There is. So we offer our customers, we call it a sales tax risk assessment, where you can provide a sales information, the quantity of sales, going back four years.

And that’s that first step that we can look at it and say based on all of this information, we think you’ve reached this threshold and you should have become a taxpayer. And then we can also do a calculation to see what that tax liability looks like. And based on all of that assessment, then they’ve got some options. You can do what’s called a voluntary disclosure, which means Avalara or somebody reaches out to these jurisdictions and say, hey, we’ve got somebody that didn’t collect tax and they should have, I’m not going to tell you who they are but if you agree to waive the penalty and limit how far you look back, we’ll get them registered, get them filed, and then we’ll tell you who they are.

If it’s a small amount, you can certainly just register and file those back returns. A lot of it really depends on how much tax we’re talking about.

Do tariffs have an impact on sales taxes for SaaS companies?

Steve Keifer:
We are recording this in the first half of 2025 and certainly the US initiated trade war and all these tariffs that we’ve announced has dominated that business news headlines for the past few months. I know it’s relatively early, but are you seeing any kind of reaction from any of the customers or businesses that you’re working with? Is there anything that they’re doing differently as a result of some of these potential tariffs?

Christine Martin:
We’re calling it whiplash because just when you think you got this under control, whoops, nope, that the rate has changed or it’s no longer there and what’s tariffed, what isn’t. I don’t know how people do this manually myself. What we have seen over and over and over again are companies wanting to add a tariff surcharge on their invoice.

They may be paying these tariffs, paying higher rates when they import things and they don’t necessarily want to increase their prices, but they want to recover these tariffs that they’re paying on import. They’re adding a line on their invoice for these surcharges. Here’s where we get into some crazy depend situations is where you report that surcharge on an invoice can impact the taxation of it.

I kind of think of it above the line and below the line. Above that subtotal line, it’s a separate line item, then it may take on the life of the other items that are being invoiced taxability-wise. If you’re selling something that’s taxable and you’ve got this tariff surcharge, most likely that tariff surcharge is gonna be taxable. But if you put this tariff surcharge below that subtotal line and it’s not related to any one thing, it’s almost always taxable.

Companies, as a way of recovering some of these costs so that they’re not taking a hit themselves, are adding these surcharges. I just caution everybody to be very careful about how you put it on an invoice, because it could impact their tax obligations.

Steve Keifer:
Yeah, so they’re adding these surcharges to try to recover some of the taxes they’re having to pay on the imports and then they’re getting taxed on the surcharge as well.

Christine Martin:
Well, they’re not getting taxed. They’re passing a, they’re having to tax their consumers as they bill it. But yeah, that’s exactly what they’re doing. I mean, imagine 125 % surcharge that you’re paying when you import it. That really hits your bottom line. So why not recover it? When I was at the telephone company, we had a property tax surcharge and we charged every single one of our customers a property tax surcharge. And our tax department became a profit center. Because the money that we brought in from these property tax surcharges more than covered our property tax expense.