Texas SaaS Sales Tax: the 80% Rule, Local Rates and Permits

Is SaaS taxable in Texas?

Yes. Texas taxes software as a service as a data processing service, a taxable service under Tax Code section 151.0101. The Comptroller says sellers of software as a service are data processing providers. The tax is the 6.25% state rate plus any local tax, charged on 80% of the price (Rule 3.330). That is 5% of the full price in state tax, and at most 6.6% with local tax.

A Texas SaaS case is not simple when:

• the invoice bundles the subscription with support, training or consulting;
• one customer uses the product in Texas and in other states;
• the seller has no Texas office but Texas revenue is near the permit line;
• the product is also taxed under another label, such as hosting or streaming;
• earlier Texas months were billed without tax.

Gather Texas revenue by month, each customer's locations, contracts with bundled lines and any certificates on file.

Other states are covered in sales tax on SaaS and software. Hosting, colocation and GPU compute bills are in sales tax on colocation, hosting and GPU compute.

How does the 80% rule work?

Texas exempts 20% of the charge for data processing, so the taxable amount is 80% of it (Tax Code section 151.351; Rule 3.330(c)). The tax is that taxable base times the state rate and any local rate.

The exemption does not apply when the service is also taxable as another kind of taxable service, other than an information service. The same rule treats streaming video as cable television service and streaming video games as amusement service, not as data processing.

Data processing is the computerized entry, retrieval, search, compilation, manipulation or storage of data, whoever owns the computer and whoever supplies the data. Using a computer only as a tool for a professional service, such as preparing a tax return, is not data processing (Publication 94-127).

Does a bundle with support or training make the whole bill taxable?

It can. When one charge covers a taxable service and a nontaxable related service, the whole charge is presumed taxable if the taxable part is more than 5.0% of the total (Rule 3.330(e)). A subscription is almost always far above that share of its own bundle.

A related service stays outside the tax only if it is neither data processing nor another taxable service, is commonly sold on its own, and is distinct and identifiable. The rule's examples are consultation, feasibility studies, design and development, and training. Ordinary customer support is not listed, so whether it qualifies depends on the contract.

The presumption is overcome by stating the charges separately when the sale happens. If that was not done, the seller or the customer can still show the split later with documents, and the books must support it by cost or by the normal stand-alone price. Travel, meals and similar costs of providing the taxable service are taxable and cannot be split out.

The rule does not say how the 20% exemption works when the whole bundle is presumed taxable. It exempts that share of the total charged for data processing, so it likely applies to the presumed-taxable charge, but confirm that before relying on it.

Which customers' usage does Texas tax?

Texas taxes the part of the service used in Texas. The sale of a data processing service delivered in Texas is presumed to be for use in Texas until the contrary is shown (Rule 3.330(g)).

For a customer with locations in and outside Texas, only the part used in Texas is taxable. A multistate customer may use any reasonable and consistent allocation its business records support (Rule 3.330(g)(6)). A service tied to a separate part of the customer's business is used where that business operates. A service that supports general administration is used at the customer's principal place of business (Publication 94-127).

Do local taxes apply to Texas SaaS?

Yes. State and any applicable local sales and use tax are imposed on data processing (Rule 3.330(c)). Local tax cannot exceed 2%, so the combined state and local maximum is 8.25% (Publication 94-105). The cap holds even when several local taxes overlap.

Which local rate applies depends on whether the seller has a Texas place of business:

Computer servers, websites and software applications are not a place of business (Publication 94-105). The single local rate is open to a remote seller's sales of taxable items, which include taxable services such as data processing (Rule 3.286(a)(14)). Once elected, it applies to all of those sales; the rate and the election form are in Texas sales tax for out-of-state sellers. Otherwise, look up each customer address in the Comptroller's sales tax rate locator.

A Texas customer using the service in several local areas can give the seller an exemption certificate claiming multi-city benefit. The customer then reports, allocates and pays the local use tax itself, and a seller that accepts it in good faith is relieved of collecting that local tax (Rule 3.330(h)(3)).

Do we need a Texas permit with no Texas office?

Not until Texas revenue reaches the safe harbor. A remote seller, meaning an out-of-state seller whose only Texas activity is remote solicitation, with total Texas revenue under $500,000 in the preceding twelve calendar months need not get a permit or collect (Comptroller: Remote Sellers). A seller with a Texas business location, salesperson or representative is not a remote seller (Comptroller: Remote Sellers). Every data processing seller other than a small remote seller must hold a permit and collect (Rule 3.330(c)).

The test counts gross revenue from all sales of goods and services for use in Texas, under the seller's own accounting method: taxable, nontaxable and tax-exempt sales, separately stated fees, sales for resale and sales through marketplaces (Rule 3.286(b)(2)(C); Comptroller: Remote Sellers). For SaaS that is the full invoice amount, the exempt 20% included. A service counts where the customer derives benefit from it, so keep records of where customers use the product.

Once revenue exceeds the amount, the seller must have a permit and start collecting no later than the first day of the fourth month after the month it was exceeded (Rule 3.286(b)(2)(E)). Permit steps and the marketplace exception are in the Texas nexus guide. Other states' thresholds are in when you must collect sales tax.

What goes on the invoice, and which certificates relieve us of collecting?

The invoice should show taxable and nontaxable services on separate lines, each at a reasonable price, with the tax added to the taxable line. The sources reviewed set no required invoice layout. Separate lines are what overcomes the bundle presumption, and tax added to the price is a debt of the customer to the seller (Tax Code section 151.052).

A customer's permit number is not a resale certificate. The certificate must be completely filled out, and the seller keeps it for 4 years (Comptroller FAQ). Do not accept one when you know or have reason to believe the purchase is not for resale.

What if we do not collect and the customer does not pay use tax?

The customer owes it. A customer must report and pay use tax when the provider is not required to collect or does not collect the right amount (Rule 3.330(i)), and the person using a taxable item in Texas stays liable until the tax is paid (Tax Code section 151.102).

That does not protect a seller who was required to collect. After the start date, Texas expects a permit and collection. Tax for uncollected months, and how to disclose it, is in catching up on uncollected sales tax.

Tax a seller collects belongs to the state. A person who collects tax holds it in trust and is liable for the full amount plus penalties and interest. A responsible individual who controls collection or payment and willfully fails to pay it over is also personally liable (Tax Code section 111.016).

Does getting a Texas permit start Texas franchise tax duties?

It can. A foreign entity's franchise tax nexus begins on the earliest of its physical presence in Texas, the date it obtains a Texas use tax permit, or the first day of the federal accounting period in which it had gross receipts from Texas business of $500,000 or more (Comptroller: Remote Sellers).

A permit therefore starts that nexus even when receipts are lower. The report types, the no-tax-due rules and deductions are in the Texas franchise tax guide.

How do we track the year's Texas revenue and the permit date?

Keep a rolling total of Texas gross revenue for the last twelve calendar months, updated monthly, and compare it with the safe harbor. Include every Texas customer invoice, taxable or not.

Two clocks run on different periods. The sales tax test looks back twelve calendar months. The franchise test looks at the federal accounting period.

Record for each Texas customer: the billing address, where users work, the invoice lines, and any certificate with its date.

Example

These examples are illustrative and use US dollars.

Delaware company, no Texas staff

A Delaware software company has $620,000 of Texas subscription revenue in the last twelve months. That exceeds the safe harbor. Its first month over the line was March, so it must hold a permit and collect from July 1. On a $1,000 monthly subscription, 80% is $800 taxable. At the 6.25% state rate, state tax is $50, plus local tax.

Austin startup with a one-line bill

An Austin startup bills one $55,000 line: a $50,000 subscription and $5,000 of onboarding training. The taxable part is far above the 5% share, so the whole $55,000 is presumed taxable. Splitting the bill at the time of sale into a $50,000 subscription line and a $5,000 training line, if the training is distinct and reasonably priced, limits the tax to the $50,000 line, taxed on 80%, or $40,000. Whether the 20% exemption also reduces the one-line $55,000 charge is not stated in the rule.

Houston customer with an Ohio office

A Houston customer with offices in Texas and Ohio gives the seller a multistate use certificate. The seller stops charging Texas tax on that customer. The customer allocates the use between Texas and Ohio on a reasonable, documented basis and reports the Texas tax itself.

Different for you?

• You sell in many states: use sales tax on SaaS and software and when you must collect sales tax.
• Your bills include hosting, colocation or GPU compute: see sales tax on colocation, hosting and GPU compute.
• You are close to the permit line or need a permit: follow Texas sales tax for out-of-state sellers, and get startup tax help to check your revenue count and invoices.
• Texas customers were billed without tax: read catching up on uncollected sales tax. Unbilled periods, trust-fund liability and investor diligence make this a case for startup tax help.
• You now have a Texas permit or Texas receipts: see the Texas franchise tax guide.