For most of human history, taxation was simple. If you bought a table, you paid tax on the table. The table was made of wood; it was heavy; you could touch it. It was “Tangible Personal Property.”
If you hired a carpenter to fix the table, you generally didn’t pay tax on the labor. That was a service.
But in the 21st century, the line between “goods” and “services” has dissolved into the ether. We no longer buy CDs; we stream music. We no longer buy boxes of floppy disks; we subscribe to platforms. This shift to the “Cloud” has created an existential crisis for state governments. As retail stores close and digital commerce explodes, states are watching their tax revenue evaporate.
To stop the bleeding, lawmakers are engaging in a fascinating, if slightly absurd, philosophical argument: they are trying to legally prove that the Cloud is a solid object.
The “Tangible” Illusion
The core of the debate centers on how we define “tangible.” Traditionally, tangible meant something you could feel.
When software was sold on CD-ROMs in the 1990s, it was easy. You bought a plastic disc. It was tangible. It was taxed.
Then came the download. Suddenly, there was no disc. You were just buying the code. Many states initially ruled that downloaded software was tax-exempt because there was no physical medium.
Then came the Cloud (SaaS). Now, you don’t even download the code. You just access it via a web browser. It is pure service. It is the carpenter fixing the table, but the table is invisible and lives in a server farm in Oregon.
Logic would dictate that this is a service, and therefore tax-exempt. But logic doesn’t pay the state budget.
So, states began to rewrite the dictionary. New York, for example, has long taken the stance that pre-written computer software is tangible personal property, regardless of how it is delivered. Their argument is that the software performs a function as if it were a machine. If you buy a calculator (machine), it’s taxable. If you buy a calculator app (software), it performs the same task; therefore, it is the same “thing.”
The Wayfair Revolution
The turning point was the 2018 Supreme Court ruling in South Dakota v. Wayfair, Inc.
Before this ruling, a state could only tax you if you had a “physical presence” there—an office, a warehouse, or an employee. The internet broke this model. You could have a billion dollars in sales in a state without ever setting foot there.
The Wayfair ruling killed the physical presence rule. It established “Economic Nexus.” Now, your “presence” is defined by your economic footprint. If you sell enough subscriptions to people in a state, you are legally “there,” even if you aren’t physically there.
This opened the floodgates. States realized they could reach across borders and tax digital streams. But to do so, they still had to classify what they were taxing.
The “Right to Access”
This led to a patchwork of confusing definitions that differ wildly from border to border.
Some states view SaaS as a “rental” of software. Since you are paying a monthly fee to use something you don’t own, they treat it like renting a car. Rentals of tangible property are taxable; therefore, your subscription is taxable.
Other states view it as “Information Services” or “Data Processing,” which have their own specific tax codes.
Then there are the states that draw a line between “canned” and “custom.”
- Canned Software: Ideally, this is off-the-shelf software (like Microsoft Word) that is the same for everyone. It is usually treated as a product (taxable).
- Custom Software: This is code written specifically for one client. It is usually treated as a service (exempt).
But SaaS sits in the middle. It is the same platform for everyone (canned), but you configure it with your own data (custom). This ambiguity allows states to aggressively interpret the law in their favor.
The Compliance Nightmare
For a modern tech company, this creates a labyrinthine nightmare. You might sell the exact same subscription to a customer in Texas and a customer in California. In one state, you might owe 8% tax. In the other, you might owe zero. In a third state, you might owe tax on only 80% of the bill because 20% of your service is considered “training,” which is exempt.
The burden of knowing these distinctions falls entirely on the seller. Ignorance of the local philosophy is not a defense.
Conclusion
The evolution of digital taxation is a lesson in how slow laws struggle to catch up with fast technology. We are trying to apply 20th-century sales tax rules—written for furniture and farm equipment—to 21st-century digital streams.
The result is a landscape where the definition of reality changes every time you cross a state line. In one jurisdiction, your code is a service; in the next, it is a tangible good. As states become more desperate to capture revenue from the digital economy, this legal fiction—that the Cloud is a brick—will likely become the standard.
Navigating this terrain requires more than just accounting software; it requires a map of the ever-changing definitions of software as a service sales tax by state to ensure that you aren’t caught unprepared when the tax man decides that your invisible product is actually a very real liability.
