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Sales Taxation of Software-Based Transactions

By Kenneth H. Bridges, CPA, PFS     March 2015

Most states impose a sales tax on the sale of most items of tangible personal property, while typically exempting from the tax the sale of services and intangible property.  So what is a sale of software?  The sale of tangible personal property?  The sale of an intangible?  The sale of a service?  Or some combination of the foregoing?  Given that sales tax rates are typically 4% to 8% of the gross sales price, it is very important that software companies correctly answer these questions.  Otherwise, the exposure for failure to properly collect and remit sales tax can be substantial.  And for purchasers of software, these questions are also important, as the purchaser may have an obligation to pay “use tax” if the seller does not collect the sales tax.  Also, the purchaser will want to ensure that it is not improperly charged sales tax which should not apply.

Does the state in which the purchaser is resident have a sales tax?  Sales and use tax is a tax on the end user of the product.  When the seller collects and remits the tax it is referred to as “sales tax”.  When the end user instead remits the tax it is called “use tax”.  Because it is a tax on the end user, you generally have to look to the location of the buyer to determine which state’s rules apply (except, for example, where dealing with a retail sale at a physical store location, in which case the rules for the location of the store will generally apply).  45 states plus the District of Columbia have a sales tax, so in most cases the answer to this question will be yes.

Does the seller have sufficient contact or “nexus” with the state for it to require collection of its sales tax?  Even if the item you are selling is subject to sales tax, you generally must have some degree of physical contact with a state before it has the right to require you as seller to collect and remit the tax.  Otherwise, it is the responsibility of the purchaser to remit the tax as use tax.

Is the buyer exempt from sales tax?  If the buyer is a governmental agency or a nonprofit organization, then it may be exempt from sales tax.  Further, if the buyer is a reseller of your product, then you will not have to collect sales tax if provided a proper reseller’s exemption certificate.

Is your product subject to sales tax in the state in which the sale is made?  In general, most states treat the sale of canned or off-the-shelf software as taxable, while treating the sale of custom software as nontaxable.  Maintenance, support, training and installation are generally not taxable, so long as the charge for such services is separately stated from the license fee.

Does the means of delivery affect taxation?  In some states, an otherwise taxable sale of software is not taxable if delivered electronically rather than via a tangible medium.

Kenneth H. Bridges, CPA, PFS is a partner with Bridges & Dunn-Rankin, LLP an Atlanta-based CPA firm.

This article is presented for educational and informational purposes only, and is not intended to constitute legal, tax or accounting advice.  The article provides only a very general summary of complex rules.  For advice on how these rules may apply to your specific situation, contact a professional tax advisor.