3 PRACTICAL Things to Remember About Collecting Sales Tax on Software

OK, this is a complex issue, but let me see if I can put together a few practical things to remember for a company looking for investors or venture funding (at least from the perspective of a software attorney). 

1) This is a State Law Issue. You really have to look at the rules on a state-by-state basis.

• Some states don’t tax software and others do (example, NY);
• Some states only tax off-the-shelf software, but not custom software (example, MN); and
• Some states tax the software if you send a CD/media, but not if it is downloaded from the Internet (example, CA).

Takeaway: Figure out where your customers are, and then look at that state’s sales and use tax law.

2) Don’t Kick the Can Down the Road. I have seen too many software companies say ‘I will deal with this down the road’, but then find out it is really difficult and expensive to fix later. Think about it this way, you are supposed to collect and remit the sales tax to the state taxing authority, but if you don’t, you are still liable for the sales tax. It is really difficult and kind of embarrassing to call up your customer after the fact and ask them to reimburse you for sales tax on a transaction from years ago that you forgot to collect. If you don’t get the sales tax money from them, you will still likely owe that tax. By the way, this will come up during any investment or sale of your company. So the real risk is (a) you can’t collect all the money you owe the taxing authority, and (b) you still owe that amount plus interest and penalties (not a great position to be in).

3) Get Reseller (Exemption) Certificates. You don’t have to collect and remit any sales tax from companies that are reselling your software, however, get a resale certificate from them. The taxing authorities probably will ask for these certificates and if you don’t have them, then you may be paying some tax you shouldn’t owe. What needs to be in a resale certificate? Here is one example. 

So, while this is very complex and needs to be analyzed on a state-by-state and distribution basis, these are 3 practical things to remember. Any top venture capital firm will expect you to be on top of this technology and law issue. 

Here is a lot more detailed information. Sales and Use Taxation of Internet Sales: Evolving Case Law.

Disclaimer: This is for informational and educational purposes, and not legal advice provided. Consult your attorney for legal advice.