Cloudy with a Chance of Sales Tax:  The Evolving Landscape in Cloud Computing

Author:  Jana Gradeva

Jana Gradeva


SALT Services

14241 Dallas Parkway, Suite 1100
Dallas, TX 75254-2961


While the popularity of cloud computing grows, states and taxpayers face the challenging task of navigating through the fog that surrounds multistate cloud transactions. As sales tax treatment varies significantly from state to state, so does the degree of certainty. Cloud computing has become an attractive choice among businesses when outsourcing various IT functions; it allows businesses to use software, infrastructure and platforms on a subscription basis while reducing substantial initial and ongoing investment in such technology.

So What Exactly Is Cloud Computing?

Cloud computing is a buzzword that incorporates three main product categories:

  • Software as a Service (SaaS), e.g., applications and hosted software
  • Infrastructure as a Service (IaaS), e.g., databases and development tools
  • Platform as a Service (PaaS), e.g., storage and network bandwidth

The most common form is SaaS. Cloud computing does not mean downloaded software or digital products (electronic music, videos, eBooks).

The Challenges

Taxability – Taxpayers face numerous challenges when determining whether these services are subject to sales tax in a particular state, mostly because many states have not developed formal positions on how to treat such transactions. Existing laws often are antiquated and don’t reflect the current technology in the marketplace. It’s like trying to fit a square peg in a round hole for both the states and taxpayers.

To make matters worse, state revenue departments differ in how they classify SaaS. Some states refer to the software statutes to determine whether the service is taxable. States such as New York, Indiana and Pennsylvania treat SaaS as a taxable sale of pre-written software. These states generally consider software tangible personal property, taxing canned programs regardless of the delivery method. That has led to a battle of definitions between “access” and “delivery”—is remote access the same as electronic delivery? Michigan Department of Treasury always has taken the position that access is a method of delivery; however, in 2014, the Michigan Court of Claims disagreed and held that remotely accessed software is not delivered—and without delivery, SaaS is not taxable tangible property.

Other states, such as Texas, Ohio and Connecticut, historically have considered SaaS as taxable data processing, information or other computer services. Even in those cases, some states may offer additional exemptions for such services—reduced rates (Connecticut) or a reduced tax base (Texas). South Carolina has taken a slightly different route and treats SaaS as a taxable communication service. On the opposite side of the spectrum, Tennessee, Kansas and California treat SaaS as a nonenumerated or nontaxable service. Idaho has gone a step further and specifically exempted it by statute.

So is SaaS a sale or lease of tangible property, a taxable or nontaxable service, a communication service, an intangible right or something else? The answer is cloudy. However, there are a few ways to make this guessing game a bit less murky. It is crucial to review service agreements, contracts and invoices to understand the nature of the transaction. Marketing and promotional materials and company websites can help or hurt. Consistency of the overall message is important. Thorough review of statutes, regulations and any court cases on the subject could provide a bit more light to transactions at hand. But if the states have not completely figured it out, how are taxpayers supposed to know?

Sourcing & Apportionment – Once SaaS is determined to be a taxable transaction, taxpayers are immediately faced with another dilemma:  how to determine the tax base and jurisdiction. Most states are moving to tax these transactions based on user location versus software location, corporate headquarters or billing address. While it’s true the benefit of SaaS takes place where the user is located, it also is challenging to determine where users are in a multistate or worldwide context, and it becomes nearly impossible to determine operator location on floating licenses and subscriptions. Because vendors don’t always have user location information, some states allow the use of multiple points of use certificates and place the burden on the purchaser to determine which jurisdiction is entitled to the tax. In instances where user location can’t be determined, states may accept the billing address as a fallback option. Keeping good records is crucial.

To Bundle or Not – Bundles are gaining popularity by advertising consumer savings, but they can be a nightmare for tax professionals. Bundled transactions with taxable and nontaxable elements may lead to incorrect taxation where the taxable elements taint the entire bundle. Some states allow taxpayers to unbundle such elements after the fact and review each part on a standalone basis, while others consider the entire lump-sum charge subject to tax. Acceptable audit defenses include true object and essence of the transaction tests or inconsequential elements determinations.

Nexus & Startups – The technology field is no stranger to many rapidly growing startup companies. As these companies grow exponentially, noncompliance and potential sales tax exposure also grow at an alarming speed. These companies face limited resources to quickly address nexus footprints, complex taxability and multistate filing requirements. Many tech companies double and triple in size and revenue in a matter of years—or even months—and may quickly find themselves in unique noncompliance predicaments. Voluntary disclosure agreements and amnesty programs are available in many states when such potential exposure is identified. In some cases, the tax exposure is so significant that it wipes out any profits and could put a company out of business. Remember, sales tax is computed on gross sales rather than net income, so a company with significant net operating losses could still have millions of dollars of sales tax exposure. It has also become a common practice for these taxpayers to go back to their customers and back-bill for taxes not collected. This option is contingent on tax clauses in current agreements and longstanding client relationships.


  • Know the exact nature of what is sold/purchased to determine correct taxability
  • Review state law on a periodic basis to capture new developments
  • Determine where users are located
  • Bundles are not always your friends
  • Take a proactive approach to nexus before you get caught
  • Always keep good records

Cloud computing is an evolving area where taxpayers and states are steering through uncertainties and challenges in their struggle to apply old tax law to new technology. More states will continue to develop their positions, guidance and new laws. As cases are litigated in the court system, new decisions may change current taxability in various states. The winding road to tax clarity in cloud computing is paved with pitfalls and opportunities, so stay tuned.

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