Sales Tax for Software Sellers
When it comes to software as a service, there is a lot of confusion among software companies because some companies are not aware that they are taxable in some states. The realization that they may suddenly owe a large amount of taxes can be shocking, and when contacted by the state they may go into panic mode.
And that's when Michael Fleming gets the call.
Michael is the founder of Sales Tax and More and is one of the country's leading authorities for state tax issues like consulting and research, registrations, returns, nexus, drop-shipping, eCommerce, and service providers. He is a writer, speaker, and regularly presents on webinars.
In this episode, Michael Fleming is interviewed by Dr. Jeremy Weisz where they talk about state tax, payment of sales tax by software companies, and working with independent contractors.
Here’s a glimpse of what you’ll learn:
A software seller's tax problems
How Michael assisted the software seller
Working with independent contractors
Sales tax for software companies
Getting professional tax services
Resources Mentioned in This Episode
Connect with Michael
Sponsor for This Episode
Sales Tax and More assists companies and their trusted advisors like CPAs with sales tax needs. They offer consulting and research, registrations, returns, and so much more. Over the years they have assisted thousands of sellers both foreign and domestic with their tax issues in the United States and in Canada.
Episode Transcript - Audio Version
[0:10] Intro: Welcome to Sales Tax and More, your go-to resource for all things state tax-related. Now, here's your host, Michael Fleming.
[0:26] Mike: Mike Fleming here. I am the founder of Sales Tax and More and today's host of the Sales Tax and More Podcast, where we talk about everyone's favorite subject, which is of course sales tax. I have Jeremy Weisz here, who has done thousands of interviews with successful entrepreneurs and CEOs, and we're going to flip the script today, and he's going to be interviewing me.
[0:50] Jeremy: Thank you, Michael, for having me. And you, as I know, are one of the foremost experts in sales tax. So if anyone has sales tax needs, CPA, eCommerce, they should contact you. And the episode today is brought to you by Sales Tax and More. They assist companies and their trusted advisors with their sales tax needs. So they offer consulting and research, registrations, returns, and much more. Over the years, I know you've assisted thousands and thousands of sellers, both foreign and domestic with their tax issues in the United States and Canada. If you have questions, you want more information, go to salestaxandmore.com, or just listen to some more episodes here. And you know, I have a really, and you know, you joke around Mike, and you say, you know, everyone's favorite topic, sales tax, but there are some crazy stories, sales tax stories out there. And you see some interesting things, and I wanted to start with one. And it's kind of on the topic of what you don't know can hurt you, and there was a software seller specifically. And if you could talk about how did this, first of all how this software seller find you and talk about what they were experiencing?
[1:58] Mike: Yeah, absolutely. And let me give you a little bit of background to set this up first. We've got this seller in one of the states that don't have a sales tax. And he's been doing business for 30-35 years. And his college buddy is doing the accounting for the firm. And when they first started the firm out, he went to this buddy who's doing his accounting and said - Hey, where do I have to worry about sales tax? You know, as the firm started to grow and enter new states, rather than just the one state. And the college buddy, he said - Well, I think it has something to do with sales. So just make sure that all of your salespeople are, never leave the state. And they never did. And they did all of their sales by phone. Well, the state of Washington finds them, and 30 years later, and the state of Washington contacts them and says - Hey, we think that you have Nexus. How long have you been doing business in our state? And their answer was forever. And the state of Washington said - Okay, thanks very much, now give us the last seven years’ worth of your sales into the state. And you've got to pay the bank tax plus 39% interest plus penalty. And these guys told the state of California said - Oh, slow down. We don't have Nexus our salespeople never leave the state. True statement. And the state of Washington, the rep comes back to him, said - Well, we audited one of your customers, and that's a big way that states find companies, and we see reimbursements for travel expenses. So someone is coming into our state. And, you know, even independent contractors or employees coming to the state can create nexus. So that's, that's the background, you know, they ended up having to pay about $500,000 to the state of Washington. And they had, they were panicked at that point because they're saying to themselves, because the state of Washington told them - You probably have problems everywhere. They were nice enough to share that. And this company called us at that point thinking that they were going to jail, and that, they were almost in tears on the phone. And they had roughly, they calculated per their estimate about $15 million that they owed in back sales tax based upon the amount of money that they paid Washington. So if all of the states had found them, that's close to a true number there. So anyway, the first thing when they called us, we have to do, is talk them down off the ledge. No one's going to jail over this, okay. It wasn't malicious. You didn't do it on purpose. People do go to jail for not paying tax they collected, but no one's going to jail over an issue like this. Now, as soon as we explain that to him, he starts feeling a little bit better. He says - Well, maybe I'd be better off in jail because I'm going bankrupt, and I'm not going to have a place to live, I'm not gonna be able to eat. So again, we had to calm him down. So that's it. That's my first experience with this gentleman.
[5:21] Jeremy: So you talked him off the ledge, what else do you tell them?
[5:27] Mike: Tell them, there's a plan forward. And one of the reasons why they thought they were going to go bankrupt is they've got to disclose this to their bank. They've got a lot of credit lines out there. And if the bank pulls all these credit lines, they're out of business. So one of the first things they asked me is if I would talk to the bank for them, and we did. And we let them know that there's a plan. We let them know that there were some VDAs that we wanted to do, voluntary disclosure agreements, where it limits the lookback periods and the exposure. There were great amnesties at the point. Most amnesties, in general, are not true amnesties. You usually have to pay the back tax plus you get the penalty and interest waved, but you still have to pay all the back tax. In these particular VDAs, they were true, excuse me, these particular amnesties. They were true amnesties, you didn't have to pay any of the back tax penalty or interest. So we put together this program, we convinced the bank, the bank that there's a way forward, and the bank agreed to not pull the credit lines and they went one step further. Generally, when someone has a problem this big, they attack it in small bites. You know, how do you eat an elephant? One bite at a time. So then maybe they do the top five states with the greatest exposure, but the bank said - No, we want all of this taken care of. We want you to go out and do VDAs everywhere, amnesties everywhere, in all of the states and we'll loan you the money to do it. Very rare.
[7:09] Jeremy: Wow. To pay the back taxes?
[7:11] Mike: Yeah, to pay the back taxes, pay any penalties and interest that there were, and to get this over and done with as soon as possible. So it's, you don't usually have the bank volunteering to. . .
[7:22] Jeremy: Give the bank's name, and address, and phone number so we can all borrow. I’m kidding. Wow. That's, that's amazing. So that banks really worked with them to help them out in this situation.
[7:37] Mike: Yeah, it's not a big national bank, you know, is their local bank. They've had a relationship for, you know, 30 years and, you know, sometimes those small-town banks can do things that the larger banks can't and, you know, they sort of in their mind, they felt like they had to. They were in so deep already. If the company went under, they would have lost all this money.
[7:58] Jeremy: Yeah, yeah. So they had to go to other states then after this happen?
[8:04] Mike: Absolutely. Yeah. The problem was, they were using independent contractors. And the particular issue in Washington was that they had people going in and it was actually employees in Washington, but they used independent contractors also. And they were doing training, and they were doing installations on their software, and they even installed hardware. So they were selling hardware along with the software. So in a state like Washington, everything they were doing was taxable. In some states, the services are not taxable. But just having someone in another state can create nexus for you. It doesn't have to be an employee. I mean, if they're, you know, an independent contractor, what the Supreme Court has said, twice, is that you know, anyone who helping you to establish or maintain a marketplace can create nexus for you. So, you know, anyone who's facing the public who's an independent contractor, you know, there's a good chance that they're actually creating nexus for you,
[9:15] Jeremy: Michael, do most software companies know they should be paying sales tax or?
[9:22] Mike: It's a rapidly evolving field and you know, everyone used to deliver software on a disk. And you know, software companies understood that a little bit. They didn't understand this independent contractor, but they knew that they were delivering something tangible and most of the states had written special rules for software being delivered on a disk or some other type of tangible medium. As the rules started changing, and people were downloading software, or even, you know, software as a service, there's a lot more confusion around there. I'm talking to, you know, SaaS companies right now that just don't understand they’re taxable in some states. You know, maybe their attorney, or maybe their accountant has told them - Well services aren't taxable. So therefore what you're doing is a service and you're not taxable. Then they get, you know, contacted by state, and then they go into panic, and then that's when I usually get the calls. Or they hear something from one of their friends. The states are trying to keep up with technology. So we're seeing changes happen all the time. That's number one, the taxability issues themselves. What was not taxable, you know, one day, maybe taxable the next day. And we're seeing that change extremely, extremely rapidly. But now, we've got this big, you know, Wayfair case. And maybe someone really didn't have nexus anywhere. They were doing everything from their home state and people were downloading the software in these other states, and they don't realize that what creates nexus now has changed. You know, earth-shattering this Wayfair case. You no longer need a physical presence in a state. And that's, you know, been the precedent for over 50 years. So now you got a company who truly never had any exposure anywhere, you know, if they're over the thresholds in these states could have, you know, exposure in, you know, up to 46, 45 states plus Washington DC, so, lots and lots changing out there.
[11:34] Jeremy: So SaaS companies should contact you if they have questions. You deal with SaaS companies?
[11:40] Mike: Yeah, and, you know, not every state actually defined SaaS the same way. So a lot of the questions we're getting now are, - Am I taxable in this state? And I'm Saas. Well, are you sure you’re SaaS? You know, let's take a look at it. Let's you know, get into it. Because, you know, data storage, a lot of states exclude that from the definition of SaaS. So not only can you just say I'm SaaS, because if you are then you know, you may be, this one company the other day that we did a project for wanted to get registered in the 20 some odd states that you know, tax software as a service, and they only needed to get registered in like three or four of them. So. . .
[12:29] Jeremy: You have to know the nuances.
[12:31] Mike: Exactly. The devil is always in the details there. So you know, anyone can read a chart and the chart can say you’re taxable or not, but you never want to make any final decisions based on a chart. Because the chart, you know, it's the first thing you want to look at. You know, is there a potential issue here? It'll steer you in where you got to do deeper research, but the chart can't possibly cover all of the different fact patterns and scenarios that are going to affect whether or not you need to collect the tax.
[13:06] Jeremy: So what should that company have done, that software company, in the beginning?
[13:11] Mike: They should have contacted someone who was more familiar with sales tax. I mean, this is your business. After your family, this is the most important thing to you, because it's how you provide for your family. So most accountants we work with are excellent at what they do. And they also know what they don't know. And they're very reluctant to give advice. They want to go out there and find companies like us that they can refer their clients to, that they know we're not going to compete with them and handle their clients well and in an ethical manner. This particular CPA, he gave advice without really knowing it, I mean, he flat out told him - I think it has something to do with this. And this company, you know, at that point, they were only in a few states, but they grew to be in every state and Canada.
[14:08] Jeremy: In the beginning, it may not have mattered when they were small. But then as you grow, you forget, you didn't really set it up the way you should have in the beginning.
[14:16] Mike: Right. And, and they keep, you know, coming back saying - Well, it's never been a problem before. And that's a true statement. It's just like speeding, you know, you could speed you know, every day. And it's not a problem until you get caught. And the same thing here.
[14:32] Jeremy: That’s never a good excuse. It's the same thing when we grew up, there were no seatbelts, right? You know, sometimes like - Well, you know, if you have your, you know, my parents will watch the kids - Well, we didn't do that. I'm like - Yeah, but we also didn't have to wear seatbelts, like, is that safe? You know, so sometimes those that that logic doesn't really work.
[14:51] Mike: I got a question for you now. How much fear do you think that CPA had when he was told what his advice had done to this company, you know, down $15 million. Is he thinking lawsuits? You know, at best, you know, it's a tarnished relationship. Right at worst, you know, he's making a claim on his errors and omissions, you know, and that’s. . .
[15:20] Jeremy: That's not a good situation.
[15:22] Mike: It's not a good situation. This is a college buddy. You know, they've been friends for 30 years, and in this particular situation, they kept the relationship but a lot of relationships would not survive that. So cautionary tale on that side, you know, bring in a subject matter expert, anybody.
[15:42] Jeremy: It's probably not often in life, Michael, that people end up paying whatever 500,000 or a million dollars and then thanking the person for it afterward.
[15:53] Mike: Yeah, this one here, when all was said and done, they paid somewhere around a million dollars. And our fees were high, and they thanked us profusely. And the reason they did is because they truly thought they were going to jail, and then they thought they were getting bankrupt. And they got out for, we got the number down substantially. Nowhere near that 15 million, like we're saying, right around that million dollar range with our fees in there. And they, you know, they loved us. It's hard for me to fathom that. I mean, it's, you know, we're still the agent who you know, gave the states the money for them. But they were truly happy, and good relationships with them to this day.
[16:44] Jeremy: Thank you for sharing that story, Michael, And people can go to salestaxandmore.com to find out more information about what you guys do. Check out more episodes of more crazy sales tax stories. Michael, thank you.
[16:59] Mike: Thank you, Jeremy.
[17:00] Outro: Thanks for listening, be sure to click subscribe and check out all of the resources we have out on the web.