What Should Your Business Do When a Vendor Asks About Use Tax on SaaS?

How to evaluate vendor inquiries, assess multistate use tax obligations, and prepare for changing digital-product tax rules

If your business purchases software or software-as-a-service (SaaS), you may receive a notice from a vendor asking whether you have self-assessed use tax on those purchases. These requests can raise an important question: Does your business have a use tax obligation when the vendor did not collect sales tax?

The answer depends on the state, the type of software or service purchased, how or where it is used, and other facts surrounding the transaction. As states continue to update how they tax digital products and SaaS, businesses should understand their purchasing activity and use tax processes before responding to vendor inquiries.

California provides a timely example. Beginning January 1, 2027, California Senate Bill 122 (SB 122) expands the state’s sales and use tax treatment of digital products, including certain prewritten software and SaaS.

Why might a vendor ask whether you self-assessed use tax?

Generally, sales tax is collected by the seller when required. Use tax can apply when a taxable purchase is made without the applicable sales tax being collected. If the vendor is under audit or in a due diligence transaction, they may reach out to ask if the use tax was self-assessed or inquire if there is an exemption.

As a result, a vendor’s question about self-assessed use tax should not automatically be treated as confirmation that your business owes tax. Instead, it may be a reason to review the transaction and determine whether the purchase was taxable in the state where the software was used or in the bill to state.

Businesses that purchase SaaS or other digital products across multiple states can face additional complexity because states do not necessarily tax these products in the same way. The location of the users, the nature of the product, available exemptions, and the applicable sourcing rules can all affect the analysis.

What is changing for SaaS purchases in California?

SB 122 significantly changes California’s treatment of certain digital products. Effective January 1, 2027, California generally treats the transfer of rights to use digital products electronically or remotely as taxable transactions. This includes prewritten computer software, whether it is downloaded or remotely accessed, including many SaaS offerings.

Custom software generally remains excluded when it is prepared to the customer’s special order, even when it incorporates certain preexisting program components. Other exceptions may also apply depending on the facts and circumstances.

The legislation also establishes sourcing rules for digital products. Depending on the transaction, sellers may look to information in their records, including customer address information, to determine where a transaction should be sourced.

For businesses purchasing software used in California, these changes may mean that purchases that historically did not include California sales tax could become taxable beginning in 2027.

What should your business do when it receives a use tax inquiry?

Before responding to a vendor, consider reviewing both the specific transaction and your broader use tax procedures. Key questions include:

• What did your business purchase? Determine whether the product is prewritten software, SaaS, custom software, or another type of digital product.
• Where is the software being used? If team members in multiple states access the software, the sourcing and tax treatment may require additional analysis.
• Did the vendor collect tax? Review invoices to determine whether sales tax was charged and, if so, where it was sourced.
• Did your business already self-assess use tax? Review accounts payable and use tax accrual records before responding to the vendor.
• Does an exemption or exception apply? The nature and use of the software may affect whether the transaction is taxable.  Or was the product resold to a customer?
• Are your processes prepared for changing state rules? Businesses with significant SaaS spending may benefit from reviewing how accounts payable systems identify purchases on which tax was not collected.

For California specifically, businesses should also be aware of special purchaser-level requirements for certain large transactions. SB 122 can shift tax remittance responsibility to the purchaser under specified circumstances involving transactions exceeding $5 million in aggregate, making accurate purchasing and tax records particularly important.

Why review use tax procedures now?

A vendor inquiry can be more than an isolated compliance question. It can provide an opportunity to evaluate whether your organization consistently identifies taxable purchases across the states where it operates.

California’s new treatment of digital products illustrates why this review is increasingly important. Businesses may purchase numerous cloud-based applications for finance, human resources, operations, sales, data management, and other functions. Changes in state tax treatment can affect both the cost of these purchases and the business’s responsibility when a vendor does not collect the applicable tax.

Ahead of California’s January 1, 2027, effective date, businesses that purchase SaaS should consider identifying significant software contracts, reviewing where users are located, evaluating current use tax accrual procedures, and determining whether their systems can appropriately identify taxable software purchases. California is also expected to provide additional administrative guidance that may clarify certain aspects of the new rules.

How Keiter can help.

If your business has received a vendor inquiry about self-assessed use tax, or if you are evaluating how changing SaaS tax rules may affect your organization, Keiter’s State & Local Tax specialists can help you review your purchasing activity, assess potential sales and use tax obligations, and identify areas where your compliance processes may need attention.

Contact your Keiter Opportunity Advisor or Email | Call 804.747.0000 to discuss your organization’s sales and use tax considerations.