State and Local Tax 101: What Every U.S. Business Should Know

Published on:

April 4, 2025

What is Use Tax?

A use tax is a tax you pay when you buy something from outside your state and bring it into your state to use, but you didn’t pay sales tax on it at the time of purchase. It’s like a backup to ensure the state still gets tax revenue on goods used within its borders.

Let’s say you live in California, where the sales tax rate is 8%. You buy a $1,000 TV online from a seller in Nevada, where there’s no sales tax charged on your purchase.

If you bought the TV in a California store, you’d pay $80 in sales tax. But since you didn’t pay sales tax to the Nevada seller, California expects you to pay a use tax of $80 to cover the tax you would’ve paid locally.

i) Use Tax Compliance for Businesses

Use tax typically applies when sales tax hasn't been collected at the time of purchase, especially for items bought out of state or online.

Here’s a quick guide to keep your business tax compliant:

Track services purchased without sales tax, such as out-of-state and from online vendors
Report and pay use tax on state income tax filings on taxable purchases.
Collect use tax on services sold based on the tax rules of your state, where no sales tax was charged.
Keep detailed records of audits for tax compliance..

ii) Use Tax Compliance for Consumers

Use tax compliance is important for consumers, too, when they purchase from out-of-state sellers or online retailers that don’t collect sales tax. In many states, consumers are required to self-report and pay use tax as part of their annual income tax filing.

Follow these tax compliance guidelines:

Keep records of subscriptions you bought without sales tax.
Verify if your state taxes SaaS and calculate the use tax
Report the use tax on your state income tax return and pay by the deadline
Save billing records for audits to prove compliance.

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What are State-by-State Tax Variations?

Running a SaaS business across the US involves dealing with different state tax rules. These variations affect how much tax you charge and pay.

One state might tax your software subscription, while in another state, it’d be tax-free. You may or may not be aware of states imposing taxes and how your business can avoid those penalties.

Let’s discuss these tax variations across different states:

1. Tax-Free States

States like Delaware, Oregon, Montana, and New Hampshire don’t charge a statewide sales tax.

But if you order something online with no sales tax or from another state, you still have to pay use tax when you bring or use it in these states.

For example, if you buy a $1,000 laptop online without sales tax in Montana, you still have to pay $70 use tax. Montana charges use tax but doesn't charge sales tax.

2. High-Tax vs. Low-Tax States

Some states, such as California and New York, impose additional taxes on sales taxes with combined tax rates over 9%, while others, like Wyoming or Wisconsin, apply taxes at much lower rates.

High taxes might push you to set up your company or sell services in a low-tax state to save costs.

3. Origin vs. Destination-Based Tax States

In origin-based states, the tax rate depends on the seller’s location, so you pay taxes of the seller’s state regardless of the product or services being sold in your state.

In contrast, destination-based states apply the sales tax based on the buyer’s location; in this case, you have to pay taxes based on the state of your purchase..

Suppose your Saas business sells a $100 subscription.

If your business is locatedin located in an origin-based state like Arizona (with a 5.6% rate), you charge the customer with $5.60 tax, no matter where they live.
And, if your customer is located in a destination-based state like Texas (with an 8.25% tax rate), you charge an $8.25 tax, regardless of your business location.

This tax difference matters for online shopping and businesses, as sellers must charge the correct rate based on the state’s rules.

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What are Local Tax Jurisdictions

Local tax jurisdictions are specific geographic areas, such as cities, counties, or districts, that have the authority to impose and collect taxes. Boundaries of multiple jurisdictions can overlap, so you might end up paying multiple taxes on one region.

These jurisdictions set their own tax rates and rules for property taxes, sales taxes, or local income taxes.

Here, we have listed these local taxes and how they are calculated:

Property taxes: Tax on your property

Property tax = Property Value * Tax Rate
If your house is worth $200,000 and the tax rate is 1.5%, you pay $3,000/year.

Sales taxes: These are taxes on your purchases on top of the base sales tax by state.

Sales Tax = Purchase Price * Tax Rate
If you buy a $100 item and the local tax rate is 2%, you have to pay $2 as Sales tax.

Local Income Tax: Tax on money you earned imposed in states like New York and Philadelphia.

Local Income Tax = Income * Tax Rate
If you earn $50,000 and the tax rate is 1%, you pay $500.

We can calculate each of those taxes easily, but complexity arises when combining those taxes for overlapping jurisdictions.

i) Tax Rate Calculation Complexity

Calculating the total tax rate is not just about the state’s rate. It’s a mix of state, country, city, and sometimes, special district taxes. Businesses need street-level accuracy as tax rates vary within ZIP codes.

If you are selling a $100 Saas subscription to a client in Houston, Texas.

With 6% state tax, 1% county tax, 1% city tax and 0.25% district tax, you have to charge $8.25 tax with a total of 8.25% local taxes.
But if you calculate local taxes with a nearby local tax rate of 6%, you may end up undercharging by 2.25%.

ii) Tax Authority Reporting Requirements

Some states make you file separate tax returns for state and local taxes, so you end up juggling multiple state tax forms. Others let you file a single return, but still want a breakdown of what you have been charged in each jurisdiction. Either way, you’ve got to track every penny by location to stay compliant.

For instance, if you sell in two cities with different rates, you report exactly the charges for each jurisdiction. It’s a lot of tax filings, but maintaining these records keeps you safe from audit penalties..

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How does SaaS and Digital Product Taxability Differ by US States?

The taxability of SaaS and digital products varies across US states, as different states classify these products or services differently, like tangible goods or intangible services.

This variation is because there is no uniform sales tax across the states. States like New York and Texas classify SaaS as a service or digital product while they are tax-free in states of California and Florida.

This may affect:

Consumers who may pay extra taxes on subscriptions by state.
Businesses struggling to comply with state-specific tax rules to avoid penalties.

Let’s break it down to understand the taxation on digital products.

i) SaaS Taxability by State

SaaS taxation varies by state based on the classification of products and services and their usage:

Full Taxation: States like New York or Texas often tax SaaS fully, treating it like software. A $100/month subscription might have $7 added tax in a 7% tax state of New York.
Partial Taxation: Some states, like Connecticut, only tax SaaS for specific uses, like business purposes, but not personal use.
No Tax: States like California don’t tax SaaS, seeing it as a service, so that $100 subscription stays $100.

ii) Digital Products Beyond SaaS

Taxes on digital products like music, eBooks, or videos vary by state, depending on whether you download or stream them or what’s included in the purchase.

Check your state’s rules to avoid unexpected taxes; we’ll break it down for you!

i. Downloads vs. Streaming: Some states tax downloads but exclude streaming, assuming streaming is not a tangible product.

A $10 eBook purchased in Minnesota would carry a 6.875% sales tax, adding approximately $0.69 to the cost. On the other hand, the state does not impose taxes on streaming services..

ii. Bundled Products: If you buy a package including software, cloud access and eBooks, states might tax only certain parts, making calculations messy. A $50 bundle might have a $2 tax on the software part but no tax on the cloud part.

Consumers might pay unexpected taxes on digital purchases, while businesses need systems to split taxable vs. non-taxable parts of a sale. Wrong tax calculations lead to audits or customer complaints.

iii) Future of Digital Taxation

As the digital economy is growing in sales, states have recognized the potential of online sales of digital products.

States are updating laws to tax SaaS services and digital goods like music or e-books. Federal and international rules may influence U.S. tax compliance.

Businesses should use tax software, and consumers should be aware of price changes.

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What to Do Once You're Liable for Sales or Use Tax

Once you start selling SaaS and digital products in a state, you are responsible for handling sales or use tax compliance.

Here’s a clear guide to keep your business on track and stay compliant with state tax rules:

i) Registration Requirements

Each state has its own forms and deadlines to register as a taxpayer. If you are selling in multiple states, you need to register in each state separately. Check state tax websites regularly for updates and submit forms before collecting taxes.

ii) Collection Obligations

Start collecting sales tax as soon as you’re registered, using the correct rate for each sale. Keep records of any tax-exempt customers’ certificates. Update your sales system to charge taxes accurately.

iii) Filing Requirements Even When Not Collecting

You must file a tax return on time, even if you had no sales or collected no tax. Filing a “zero-dollar return” keeps you compliant. Set reminders to meet state deadlines.

iv) Periodic Filing Schedules

File taxes monthly, quarterly, or annually, depending on how much you sell. Each state sets its own schedule and deadlines. Check your state’s rules and mark due dates on your calendar.

v) Record-keeping requirements

Save all sales, tax, and exemption records for several years. States may audit you and need these documents. Use folders or digital tools to stay organized.

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Managing Multi-State Tax Obligations

Scaling your business across multiple states is thrilling, but it comes with a bunch of different tax rules that can be overwhelming. Don’t let that slow down your growth. With the right strategies, you can tackle multiple states' tax compliance.

Here, we will discuss some easy ways to handle and manage tax rules:

i. Technology Solutions

Tax software makes handling taxes easier by automatically calculating the right tax rate for each customer’s location and filing returns on time. It tracks exemption certificates for tax-free sales and connects with accounting tools to cut down on manual work.

Search for good tax software to automate calculations.
Link it to your accounting system for seamless tracking.
Use it to store exemption certificates digitally.

ii. Outsourcing vs. In-House Management

You can manage taxes yourself, hire a tax professional, or combine both for a custom approach. In-house work, if you have time, while outsourcing saves effort but costs more. A hybrid model might use software for daily tasks and experts for tricky filings, fitting your budget:-

Decide if your team can handle taxes or if you need help.
Research tax services for outsourcing options.
Try a hybrid setup to save money while staying accurate.

iii. Audit Defense Preparation

Audits can happen anytime, and being ready with organized records helps to avoid penalties. Keep detailed records of sales, tax, and exemption documents for at least 3-7 years, depending on state rules. Use tax software to generate audit-ready reports and review your processes regularly to catch errors.

Store records in cloud storage for backups.
Run regular checks to make sure your tax data aligns with sales
Consult a tax expert to prepare for potential audits

iv. Voluntary Disclosure Agreements (VDA)

If you didn’t collect taxes in a state before, VDAs let you fix it with smaller penalties by reporting and paying back taxes. Most states allow you to start anonymously to understand your options safely. This helps clear past mistakes and keeps your business compliant.

Check if your state offers VDAs on its tax website.
Contact the state anonymously to explore fixing errors.
Work with a tax pro to file a VDA correctly.

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How Inkle Helps with State and Local Tax Compliance

Sales and use tax compliance isn’t just about knowing the rules - it’s about staying on top of them as you scale. Inkle gives you the tools (and human assistance) to handle multi-state tax the smart way.

Here’s how Inkle helps:

i) Know Exactly When to Register

No more spreadsheets. Inkle tracks your revenue and transaction counts by state and alerts you when you’re about to cross a tax threshold. That means you register on time, and only when needed.

ii) Get Registered, Without the Paper Chase

Filling out tax forms in five different states? Inkle organizes your info and helps you get registered fast, even across multiple states at once. No portal-hopping, no form-hunting.

iii) Charge the Right Tax, Every Time

Tax rates vary by city, county, and product type. Inkle ensures the right rate is applied for every transaction whether it's 4.5% in Kansas or 9.3% in Seattle. No overcharging. No under-collecting.

iv) Keep Exempt Sales Audit-Ready

Selling to resellers or tax-exempt orgs? Inkle collects, validates, and stores exemption certificates so your records are airtight if the auditors come knocking.

v) File On Time, Every Time

Whether you’re filing monthly in New York or annually in Colorado, Inkle’s tax experts handle it for you - accurately and on schedule. You stay compliant without touching a state portal.

vi) Connect the Tools You Already Use

Inkle plugs into platforms like QuickBooks, Stripe, and Shopify to pull transaction data automatically. That means fewer uploads, fewer mistakes, and no missed tax triggers.

If you’re looking for expert guidance or software for tax compliance for your SaaS startup, our team at Inkle is here to help. Get in touch today for specialized support.

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Frequently Asked Questions

1. If my business is in a tax-free state, do I still need to collect tax for sales to other states?

Even if your business is based in a state without sales tax, you may need to collect sales tax for sales to customers in other states if you have a "nexus" in those states. Nexus is a connection that triggers tax obligations, such as having a physical location, employees, or significant sales activity in a state.

2. Does having a remote employee in a state create nexus?

Yes, having a remote employee in a state can create nexus, requiring you to collect and remit sales tax in that state. A remote employee working from home may establish a physical presence for your business, triggering tax obligations.

3. If I registered for sales tax but haven't made any sales, do I still need to file returns?

Yes, you still need to file sales tax returns even if you haven’t made any sales during the reporting period. This is usually done by submitting a "zero return," where you report no taxable sales, to remain compliant with tax filing requirements.

4. How do I determine if my digital product is taxable in a specific state?

To determine if your digital product is taxable, review the state’s tax laws on digital goods, as taxability varies widely. Some states tax digital products like software, e-books, or streaming services, while others do not.

5. What's the difference between sales tax and seller's use tax?

Sales tax is a tax you collect from customers at the point of sale, based on the transaction’s location and the state’s tax rate, then remit to the state. A seller’s use tax, on the other hand, is a tax you, as the seller, pay to a state when you sell to a customer in a state where you’re not required to collect sales tax, but the customer is still obligated to pay tax on the purchase.