What happens when you don't pay sales tax? A quick guide for SaaS and digital products

Common misconceptions: Why do some companies not pay sales tax?

Most SaaS and digital product companies that don’t pay sales tax aren't intentionally evading it. A lot of businesses, especially app companies that are used to app stores handling tax obligations, are simply operating unaware of tax law applies to digital businesses.

Software isn't subject to sales tax

This might have been true 15 years ago, but it's not anymore. Most US states now explicitly tax SaaS, digital downloads, and cloud-based software. Some states classify these products as tangible personal property, while others have created specific digital goods categories. Either way, your product is taxable. 

The confusion stems from the fact that each state treats tax differently. A handful of states still don't tax SaaS, but the majority do. If you assume that your products are automatically exempt, you’re setting yourself up for unexpected tax bills further down the line.

Find the 2025 rates for SaaS sales tax by state here.

We don't have nexus in other states

Physical presence used to be the standard for establishing nexus but that changed with the 2018 Supreme Court decision in South Dakota v. Wayfair. Now, economic nexus rules apply.

Economic nexus means you can trigger tax obligations based purely on the volume of sales or transactions in a state, even if you don't have a physical presence there. 

Most states set thresholds around $100,000 in sales or 200 transactions annually. Growing SaaS companies selling nationwide can easily cross these thresholds in multiple states without realizing it.

We're too small for states to notice

State tax authorities have gotten sophisticated about identifying non-compliant businesses. They use data from payment processors, marketplace facilitators, and even web scraping to find companies that should be collecting tax but aren't.

The risk compounds as you grow. What starts as a small oversight in year one becomes a substantial liability by year three. States can audit several years of back sales, and the amounts add up quickly when you're looking at compounding penalties and interest.

Our payment processor handles this for us

Most payment service providers (PSPs), including Stripe, don't automatically handle sales tax compliance, and thinking that they do is a dangerous misconception. For instance, Stripe offers tax compliance through Stripe Tax, a separate product that requires additional configuration and fees. You're still responsible for monitoring nexus, determining where to register, and ensuring accurate tax collection.

The PSP processes your payments, but tax compliance remains your responsibility unless you work with a Merchant of Record (MoR). Find out more about how Paddle handles tax compliance.

What happens if a company doesn't pay sales tax at all? 

When you fail to collect and remit sales tax, you're risking penalties and accruing a tax debt to the state that grows larger over time. States take sales tax seriously because it's a significant revenue source that they can enforce whenever people don't pay.

Back taxes and penalties

The primary consequence is owing the full amount of uncollected sales tax. This comes out of your revenue, not from customers who should have paid it originally. You can't retroactively collect tax from customers who made purchases months or years ago.

In addition to the back taxes, states assess penalty fees. These typically range from 5% to 25% of the unpaid tax, depending on the state and how long you've been non-compliant. Some states apply penalties monthly, so a six-month delay could mean multiple penalty assessments.

Interest charges

States charge interest on unpaid tax from the date it was due. Interest rates vary but commonly fall between 3% and 10% annually, compounding monthly. Unlike penalties, which might be capped or negotiated, interest continues accruing until you pay the full amount.

For example, a SaaS company with $500,000 in taxable sales in California over two years would translate to roughly $36,250 in unpaid tax, given California's sales tax rate is 7.25%. Add a 10% penalty and 6% annual interest compounding over two years, and you're looking at nearly $41,000. That's 8% of your original sales.

Legal consequences

While it's uncommon for people to go to jail for not paying taxes, in extreme cases, a failure to pay sales tax can result in criminal charges and jail time. States may pursue criminal prosecution if they believe a company deliberately evaded tax obligations, particularly when large amounts are involved or when there's evidence of intentional fraud. If you collected tax from customers but used those funds for other business expenses instead of remitting them to tax authorities, states view this as theft of government funds.

More often, states will pursue civil penalties and liens. A tax lien becomes public record, which can complicate fundraising, acquisitions, or even routine banking relationships. Investors conducting due diligence will uncover tax liabilities, and that's often a deal-breaker.

Consequences of not paying sales tax on time

Even companies that understand their tax obligations sometimes fall behind on filing and payment. Late payment is less severe than non-payment, but it still has consequences.

• Penalty fees for late filing: Most states assess a penalty for filing sales tax returns after the deadline, even if you pay the full amount of tax owed. These penalties typically range from 5% to 10% of the tax due, with some states imposing a minimum penalty regardless of the amount owed.
• Penalty fees for late payment: Paying late, even if you file on time, triggers separate penalties. States distinguish between filing deadlines and payment deadlines, and missing either creates additional liability. Late payment penalties often mirror late filing penalties, meaning you could face both at the same time.
• Compounding interest: Like non-payment scenarios, late payment accrues interest from the due date until you pay. The interest rate and compounding frequency vary by state, but the clock starts ticking the day after the due date.
• Increased audit risk: Consistent late filing signals to state tax authorities that your compliance processes are weak. This can trigger sales tax audits, which are time-consuming and expensive even when they don't uncover additional liabilities. Once you're on a state's radar for compliance issues, you're more likely to face heightened scrutiny in the future.

Loss of timely filing discounts: Some states offer small discounts for timely filing and payment, often 1% to 2% of the tax due. Late payment means forfeiting these discounts, which can add up over time for high-volume businesses.

6 tips on how to avoid sales tax penalties

Sales tax compliance for your digital products requires ongoing attention. You can't set it up once and forget about it, because your obligations change as your business grows and as state laws change. Here are some tips to keep up with compliance: 

1. Monitor nexus thresholds in all states

Track your sales by state monthly. Most states set economic nexus thresholds at $100,000 in sales or 200 transactions per year, but some states use different thresholds. When you approach a threshold in any state, you need to register before you cross it.

This requires reliable data. Your payment systems should accurately capture customer locations, and you need reporting that breaks down sales by state in real-time. Waiting until year-end to check your exposure means you're already non-compliant.

2. Register for sales tax permits before you hit nexus

Once you determine you have nexus in a state, register for a sales tax permit before making your next sale there. Registration processes vary by state. Some are quick and online, while others require paper applications and processing time. 

After registering, states assign you a filing frequency, typically it's monthly, quarterly, or annual, based on your expected sales volume. Missing this initial filing deadline starts the penalty clock immediately.

3. Collect sales tax at the point of sale

Your checkout system needs to calculate and collect the correct sales tax for each transaction. This is more complex than it sounds for digital products, because tax rates can vary by product type, customer location, and specific state rules about digital goods.

Many companies use tax calculation APIs or services to manage this step of the process. It's important for your system to update when rates change (and they change frequently). Managing rates manually doesn't scale and creates compliance gaps.

4. File returns and remit payments on time

Mark filing deadlines clearly and build in buffer time. Sales tax returns typically require detailed transaction information, not just payment. States want to see how you calculated the tax you collected, which means reconciling your sales data, tax collected, and any exemptions or deductions.

Set up automated reminders well before deadlines. For states where you file monthly, you're managing 12 deadlines per state per year. Miss one, and you're dealing with penalties and additional administrative burden.

5. Keep detailed records

States can audit sales tax compliance for several years. Maintain transaction-level records that include customer locations, product types, tax rates applied, and the amount of tax collected. If you claim any exemptions, keep the exemption certificates on hand.

Good record-keeping also helps you identify compliance issues early. If an audit reveals problems, detailed records demonstrate a good-faith effort and can sometimes help reduce penalties.

6. Use a Merchant of Record like Paddle

All of these compliance steps require significant time, expertise, and ongoing attention that could be spent building and scaling your products and distributing to customers across the globe.

For SaaS and app companies, an MoR changes the game entirely. When you work with Paddle, we become the seller of record for your transactions. That means sales tax compliance becomes our responsibility, not yours. This includes:

• monitoring nexus
• registering in all required jurisdictions
• collecting tax
• filing returns
• remitting payments 

This isn't an add-on service with additional fees. Tax compliance is built into Paddle's core offering as an MoR. Companies like Letterboxd and Runna have moved to Paddle specifically to offload tax obligations. Stape's team noted that handling tax compliance across multiple jurisdictions was pulling focus from product development. That's exactly the problem an MoR solves.

For growing SaaS and app companies, the peace of mind is worth it. You're not just avoiding penalties, you're eliminating an entire category of operational complexity that doesn't differentiate your product or create customer value.

Speak to an expert to find out how we can help your business stay compliant as you scale globally.