Taxability of software can wear you down

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Guest post by Mark L. Stone, CPA, MST

This week, the REM Cycle is pleased to welcome Mark L. Stone of Sales Tax Defense LLC as  guest blogger. Mark is an expert on Sales and Use Tax, and has served as an expert witness, testifying in tax court on behalf of his clients. Mark can be contacted here.

Software is prominent in today’s world.  Just to read this blog post, you’re using software.  It’s everywhere.  But it wasn’t prominent when most sales tax law was written and that’s an issue.  Trying to fit the definition of software into a pre-internet world tax code is like trying to fit a square peg into something even worse than a round hole.  The states are catching up though and issuing a lot of guidance about what software is, the taxability of different types of software and whether certain services are actually the sale of software.

The definition of software in many states is usually something along the lines of a set of coded instructions designed to cause a computer or automatic data processing equipment to perform a task.  That’s Georgia’s definition.  But some states, like Maryland, don’t even have a formal definition of software in their tax code.

Knowing this information, here’s a few helpful hints to understand the taxability of software:

  1. Understand that what you believe you’re selling and what you are selling as defined by the tax law are often two different things. For example, “software as a service” is not defined under the tax law in many states.  If you operate in one of those states, what are you selling then?
  2. There is usually a difference between prewritten software (aka canned software) and custom software.  Sometimes combining two pieces of prewritten software does not quality as custom software.
  3. In certain states, there are situations where you can be selling taxable prewritten software but a separately stated charge for customizations to that software are not subject to tax.
  4. If you host software that customers access through the internet, there is often specific information or documentation that must be maintained to prove that customer is located in a different state.
  5. There are often very specific rules relating to software sold via the “load-and-leave” method – both for taxability purposes AND for nexus purposes.
  6. SHOCKER SPECIAL:  If your customers access software electronically and you pay a third party to host that software, it might create nexus with a state.  That means you might owe tax in a state that you didn’t realize you had any connection with.

Someone once said that a computer programmer is a machine that turns coffee into code.  If you sell software, let us be the machine that turns your tax problem into… well... not a tax problem!

This article originally appeared here.