What records should software businesses keep for sales tax compliance?

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A: For software businesses, especially those providing Software as a Service (SaaS), maintaining proper records is essential for sales tax compliance. The complexity of sales tax for software companies arises from the varying taxability of SaaS and digital products across states, the need to track economic nexus thresholds, and the requirement to substantiate all sales, exemptions, and remittances. Below is a comprehensive guide to the records software businesses should keep, the legal requirements, and best practices for compliance.

1. General Recordkeeping Requirements

Under federal law, every person liable for any tax must keep records sufficient to show whether or not they are liable for tax. Specifically, Internal Revenue Code Section 6001 states that taxpayers must keep such records, render such statements, and make such returns as the Secretary may prescribe. The IRS and state tax authorities may require additional records as necessary to determine tax liability [1].

IRS Publication 583 further clarifies that businesses must keep records that support the income, deductions, and credits reported on their tax returns. These records must be available for inspection and should clearly show income and expenses. For sales tax, this means keeping detailed records of all sales, the tax collected, and any exemptions claimed [2].

2. Specific Records for Sales Tax Compliance

a. Sales Records

• Invoices and Receipts: Maintain copies of all invoices and receipts issued to customers, showing the date, amount, description of the software or service, and the sales tax charged (if any).
• Sales Journals/Ledgers: Summaries of daily, monthly, and annual sales, including taxable and nontaxable sales, are essential for reconciling reported sales with tax returns.

b. Tax Collected and Remitted

• Sales Tax Returns: Copies of all filed sales tax returns for each jurisdiction.
• Remittance Records: Proof of payment for all sales tax remitted to state and local authorities.

c. Exemption Documentation

• Resale and Exemption Certificates: If a customer claims an exemption (e.g., resale, nonprofit), retain a valid exemption certificate for each exempt sale. These must be kept for the period required by the state, often at least as long as the statute of limitations for sales tax assessments.

d. Customer and Transaction Data

• Customer Location Information: Since sales tax is often based on the customer’s location, keep records of customer addresses, billing, and shipping information.
• Product/Service Classification: Documentation showing how each product or service is classified for sales tax purposes (e.g., SaaS, downloadable software, custom software).

e. Nexus and Threshold Tracking

• Economic Nexus Analysis: Maintain records of sales by state to monitor when economic nexus thresholds are met (e.g., $100,000 in sales or 200 transactions in many states).
• Physical Presence Records: If you have employees, contractors, or property in a state, keep documentation to support or refute physical nexus.

f. Supporting Documentation

• Bank Statements and Deposit Slips: To verify sales receipts and reconcile with reported income.
• Contracts and Agreements: Especially for SaaS and software licensing, as these can affect taxability.
• Correspondence with Tax Authorities: Any letters, notices, or rulings received from state tax departments.

3. Retention Periods

Most states require that records be kept for at least three to four years, which aligns with the statute of limitations for sales tax assessments. However, if a return is not filed or there is a substantial omission, states may assess tax at any time or for extended periods (e.g., six years or more) [3]. It is prudent for software businesses to retain all sales tax-related records for at least seven years.

4. Best Practices for Software Businesses Tax Compliance

• Use Automated Solutions: Consider using robust accounting and sales tax compliance software to automate recordkeeping and reduce errors. However, be cautious and avoid common mistakes. See Avoid Expensive Sales Tax Compliance Software Mistakes with Avalara.
• Leverage SaaS-Specific Tools: For SaaS startups, platforms like Sage Intacct offer features tailored to the needs of software businesses. See Top Features of Sage Intacct for SaaS Startups.
• Regularly Review Nexus and Taxability: As states frequently update their rules, regularly review where you have nexus and whether your products are taxable. For example, SaaS is taxable in some states (e.g., Connecticut, New York) but not in others (e.g., California, Florida).
• Train Staff: Ensure that your finance and sales teams understand the importance of collecting and retaining proper documentation for all sales and exemptions.

5. Do Software Company Need Sales Tax?

Yes, software companies often need to collect and remit sales tax, depending on the states in which they have nexus and the taxability of their products or services. It depends on the specific state’s rules and the nature of the software offering. For example, SaaS is taxable in some states and exempt in others, so it is critical to track where your customers are located and understand each state’s requirements.

In summary:
For sales tax software companies, meticulous recordkeeping is the foundation of software businesses tax compliance. Keeping comprehensive, organized, and accessible records not only ensures compliance with state and federal laws but also protects your business in the event of an audit.

Cited sources

[1]Sec. 6001 Notice or regulations requiring records, statements, and special returns

[2]Publication 583 (12/2024)

[3]How long should I keep records?

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