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Why startups are addressing sales tax now

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Last Updated

Why startups are addressing sales tax now

Anrok | Streamlined sales tax for SaaS

There are many priorities for a software startup’s finance team. Among those is one that has gained importance lately: Sales tax.

Managing this is a relatively new challenge for many software startups due to a change in rules prompted by a 2018 U.S. Supreme Court case. This ruling and the cascading changes in state laws that have resulted mean that many companies are suddenly out of compliance when it comes to sales tax.

Should you tackle sales tax compliance right away? It can be hard to figure out when to prioritize it over all the other tasks that a busy finance team handles. When to do so depends on your company’s exposure and risk tolerance. But unless the former is low and the latter high, it makes good sense to achieve compliance with sales tax laws as soon as possible.

That’s the advice of Brad Silicani, Anrok’s finance and operations director, which we’ll delve into later in this post. First, a brief look at why sales tax law is suddenly a moving target.

Why is sales tax a new problem for software startups?

Prior to 2018, U.S. federal law only allowed states to hold a company responsible for collecting and remitting sales tax if the company had a “physical presence” in a given state. That presence — known as nexus — could be triggered by various things in the state, including maintaining an office or warehouse, having staff, or doing certain types of business in-person.

However, in 2018, the South Dakota v. Wayfair U.S. Supreme Court case said states could pursue laws that would define nexus economically. As a result, states across the nation enacted economic nexus laws, stating that companies that had a certain number of transactions or volume of sales (or a combination of both) could be considered to have nexus there.

Software startups are particularly affected by this change in law. Since they typically sell their products remotely — often hosted in the cloud or as a digital download — and tend not to maintain offices or warehouses in many states, many software startups haven’t had to worry about nexus in states other than where they had a physical office. But now they need to look at whether they have reached each state’s threshold for economic nexus. Rules vary by state. Companies that reach a given state’s threshold must collect and remit tax on sales to customers there to remain in compliance with the state’s tax laws.

Getting into compliance with the laws of every state is a complex and time-intensive process, which serves up a dilemma to software startups suddenly beholden to new laws all over the country: How urgently to pursue compliance?

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Table of contents

Brad Silicani on finance priorities for startups

Brad Silicani, Anrok’s finance and operations director, spends a lot of time thinking about when it makes sense to address sales tax relative to all other issues that a finance leader must navigate.

It may seem like a difficult question — and there’s no doubt that juggling a company’s financial priorities is a difficult task. But Brad comes down consistently on the side that solving sales tax will provide significant time and financial benefits that far exceed the initial hurdle of putting a tax engine in place. Here are three reasons he urges startups to get a handle on this major aspect of business finance right away.

  1. Non-compliance costs time and money. Simply put, non-compliance unnecessarily reduces your profitability and revenue. If you fail to collect sales tax you are legally required to remit, you still owe that tax to the given state. This means that whenever that state catches up with you, you’ll be on the hook to pay the tax that you could have collected from customers, plus any penalties and interest accrued due to your tardiness. Until you pay the outstanding sales tax due, you will need to book this as a liability and it can impact future borrowing or acquisition opportunities. Addressing sales tax now makes a positive impact on your bottom line going forward. You can even quantify the impact by using our estimation framework here.
  2. Compliance demonstrates your maturity. You may believe that you can get away with staying out of compliance in various states in perpetuity. But such an attitude reflects short-term thinking that will naturally limit your company’s growth. Staying out of compliance in a given state is tantamount to saying you’ll limit your growth to a level at which you can continually fly under the radar there. A more responsible attitude demonstrates to your larger customers that you are a more mature business that is ready to play in the big leagues. Don’t forget, your larger customers will need to pay use tax if you don’t collect sales tax from them directly, so this is something that they will notice.
  3. Audit risk is real. By staying out of compliance, you run the risk of getting caught and being forced to face the consequences. In fact, it’s a near certainty that you’ll get audited eventually, especially if you have employees in numerous states. Software companies should get prepared for this eventuality by getting into compliance on sales tax as soon as possible and by putting in place a system of record for transactions and how tax was handled in each state.
  4. Your customers’ trust matters. Another reason to get into compliance with sales tax laws as quickly as possible is that large customers expect to be paying sales tax on their purchases. When a buyer purchases software from a company that should have collected sales tax, but did not, the buyer now owes use tax. Large corporations take their tax obligations seriously and may take issue with the extra work your non-compliance has created for them. If you’re a startup looking to sell upmarket, implementing sales tax now indicates to your customers that you’re a compliant and mature business.

Don’t wait for an in-house tax team

Sales tax compliance is a challenge that impacts revenue and risk for small and large software companies alike. The need is urgent, and finance leaders don't need — and probably can't afford — to wait for an in-house tax accountant or team to get sales tax compliance in place.

Luckily, you don’t have to. Anrok is specifically designed for SaaS businesses and is easy to set up and integrate with your billing and payment systems. Finance leaders at software companies can navigate the intricacies of software taxability out-of-the-box, regardless of prior experience with sales tax.

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