Most software founders treat sales tax as a solved problem once they implement a compliance platform and enable nexus monitoring. The more difficult question is not where you have nexus, but what exactly you are selling.
That answer varies from state to state. It changes when legislatures amend statutes, when tax authorities issue new guidance and when your own product evolves. As a result, a company can be fully registered, file returns on time, and still quietly accumulate sales tax exposure quarter after quarter.
There is no national definition of Software as a Service (SaaS). Revenue generated by a software company can fall into several different state tax categories, and states do not draw those lines consistently. Depending on the jurisdiction, the same offering may be treated as SaaS, information services, data processing services or prewritten (canned) software.
To a customer, the product may feel like a single, integrated solution. To a state tax authority, however, the category in which it is placed often determines whether and how it is taxed. The challenge is that the same product can be classified differently from one state to the next.
The risk becomes even greater because the classification itself is often subject to interpretation and can evolve over time. As a SaaS product matures, it frequently accumulates features that look less like pure software access and more like the delivery of information or data. A company may begin with a tool that enables customers to perform a function, then add analytics, benchmarking against aggregated customer data, data feeds, automated reporting or AI-driven insights. Each enhancement increases the product’s value, but in certain states, it may also increase the likelihood that tax authorities view the offering as an information service or data service rather than traditional SaaS.
The regulatory landscape is equally dynamic. Some states tax SaaS as prewritten software delivered electronically. Others impose tax under their data processing or information service rules. Some limit taxation to business customers, while others exempt the same type of transaction entirely. Legislatures amend statutes, courts issue decisions and revenue departments release rulings that can alter or reverse positions businesses have relied upon for years.
As a result, a taxability study should not be viewed as a one-time exercise. A conclusion reached three years ago may already be outdated in multiple jurisdictions due to changes in law, administrative guidance or the product itself. Taxability is not a static determination. It is a position that must be monitored, revisited and maintained as both the business and the tax landscape continue to evolve.
Most companies think about sales tax at the state level. They assume the state defines the tax base and local jurisdictions apply their own rate to that base. In home-rule jurisdictions, that assumption breaks down. A home-rule locality has independent authority to define its own tax base, administer its own tax regime and impose its own tax obligations separate from the state. That means a city may tax a transaction even when the state has chosen not to. It may have its own registration requirements, filing obligations, sourcing rules and tax rates. A company can therefore be fully compliant with state law while simultaneously carrying exposure at the local level.
Chicago’s requirements illustrate why SaaS, digital services and data-driven businesses need to consider local tax obligations. Illinois generally does not tax many software and digital service offerings. A company looking only at the state’s rules could reasonably conclude its product is not taxable in Illinois. The City of Chicago reaches a different conclusion. Through its Personal Property Lease Transaction Tax, Chicago taxes nonpossessory computer leases, a category that often encompasses cloud computing, SaaS and other software-access services.
The increasing tax burden has made this issue difficult to ignore. The tax rate on nonpossessory computer leases was 5.25% in 2016, increased to 7.25% in 2020, rose to 9% in 2021, climbed to 11% in 2025 and reached 15% as of January 1, 2026. For many software companies, the risk is not simply that the tax applies. It is that the tax can accumulate over multiple years before the company realizes it has an obligation.
Because the tax is sourced based on where the customer accesses and uses the service, even businesses located entirely outside Illinois can find themselves subject to Chicago’s rules. Compliance mechanics are equally important. Chicago adopted an economic nexus standard effective July 1, 2021, under which receipts of $100,000 or more from Chicago customers during the most recent four consecutive calendar quarters can create a filing obligation. Registration occurs directly with the City of Chicago Department of Finance and is not handled through an Illinois state sales tax registration. A taxpayer can therefore be properly registered, collecting and filing at the state level while remaining completely unaware of a separate Chicago obligation with its own registrations, filings and a tax rate now at 15%.
Chicago may be the best-known example, but it is far from unique. Colorado contains numerous home-rule jurisdictions that administer and collect their own local sales taxes. Denver, for example, taxes software and SaaS and requires direct registration and filing with the city. Louisiana has historically operated through a parish-level system in which local jurisdictions maintain significant authority over administration and enforcement. While the rules differ from jurisdiction to jurisdiction, the common theme remains: the local tax regime does not necessarily mirror the state tax regime.
For software companies, this means nexus reviews and taxability studies cannot stop at the state border. A conclusion that a product is not taxable in a state does not necessarily answer whether it is taxable in the cities, parishes or other jurisdictions within that state. Exposure often exists below the state line, where many businesses are not looking.
A taxability determination is a snapshot in time of a product that will continue to evolve. Product roadmaps rarely stand still. New analytics, data integrations, benchmarking tools, reporting capabilities and AI-driven functionality are added every year, and each enhancement can move a product across a taxability line in one or more jurisdictions.
For that reason, a taxability position cannot be a memorandum written several years ago and then shelved. It must be maintained. Companies that manage sales tax risk effectively focus on several interconnected disciplines.
Taxability studies should not be treated as one-time exercises. Whenever a product experiences a meaningful change in functionality, a corresponding review should assess whether that change affects the product’s classification in key jurisdictions. The objective is to identify classification drift before it becomes an audit issue.
Classification disputes are often won or lost based on how a product is described in documentation. Tax does not need to write the marketing materials, but it should have a voice in how the product is characterized in customer-facing agreements and sales documentation. Careless descriptions can create exposure, while carefully drafted language can help support a defensible position.
State taxability is only part of the analysis. Jurisdictions such as Chicago, certain Colorado localities and other home-rule jurisdictions have their own rules, tax bases and filing requirements. Ignoring these jurisdictions can leave significant gaps in an otherwise well-managed compliance program.
Most companies routinely track revenue and transaction thresholds because they understand that nexus can change. Product classification deserves the same attention. Taxability can shift as features evolve, as states revise statutes and as taxing authorities issue new guidance. The question is not whether change will occur, but whether the business is prepared when it does.
Ultimately, managing the sales tax implications of a software business is not about finding a single answer. It is about maintaining a position in an environment where the product, the law and the taxing jurisdictions are all changing simultaneously. Companies that do this well are rarely caught off guard during an audit because they have built a process to identify change as it occurs rather than trying to reconstruct it years later.
If you have questions about state and local taxes, please reach out to a member of the Withum SALT Team.
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