If you buy or sell software or computer services that are used by anyone in Massachusetts, your life just got a lot harder. The State of Massachusetts has recently increased taxes on gas, cigarettes... and software. This tax applies to all “computer software, including pre-written upgrades, which is not designed and developed by the author.” Vague and scary, right? Well, if you don’t want to be nabbed for tax evasion, here’s what you have to know.
- Anyone working in the IT industry who sells software or related services to any business that has any office in Massachusetts.
- Any company that has software “used” in Massachusetts (internal software or external software presumably) and who doesn’t do ALL of their own IT work.
It’s crazy, isn’t it? There’s already a petition on Change.org for repeal, and rumor has it the law will likely be amended, but in the meantime you should pay taxes for worse-case scenario.
Immediately. This law went into effect a couple of weeks ago, and so starting July 31st, 2013, any contractors, freelancers or IT shops need to start charging their clients tax if their software is “used” in Massachusetts. If you’re not set up to collect Massachusetts sales tax, you might want to talk to your accountant now.
“I spoke to my representative a little while ago and they confirmed that likely some percentage of work we do would be taxable and some wouldn’t be. I explained that there is no way for our techs to separate out one from the other in our current ticketing system and even if there was, I couldn’t even train them how to do it fast enough.” --Delcie Bean CEO Paragus Strategic IT
This affects a lot of software vendors whose customers use Google Apps; if they have a customer rolling out Google Apps across an industry, and they need help “customizing” or “updating” anything, the freelancers and web design shops that get this cottage industry business will now be taxed.
This added levy is not only cumbersome, it’s super confusing. For example:
- if you install software (Microsoft Office, Constant Contact, Drupal, etc.), it's taxable
- if your client clicks the mouse to install it, it's not taxable
- training your client to use this software is not taxable
- but if you "customize" or configure the software in any way, it's taxable
- if you don’t actually make any changes, but just discuss them and plan them, it’s consulting and not taxable
- if you create graphic design mockups, it’s not taxable
- but as soon as you implement that design (i.e. program it), it becomes taxable if you’re using “prewritten” software “not developed” by you (such as WordPress)
At least, that’s how we think it works. What it definitely means is that IT businesses in Massachusetts are going to take a hit. We’ve got a lot more paperwork and a lot of nuances to work out now; for instance, we lease a server and resell portions of it to our clients. The hosting costs include security patches, so some percentage of our hosting costs is taxable, even “hosting” isn’t taxable and our server isn’t in Massachusetts.
And what do you do if someone prepays for 100 hours of work that has not yet been defined? How much is going to be taxable? It seems you can't accept their money without also collecting sales tax preemptively, regardless of whether sales tax will actually apply. And, according to the Mass Department of Revenue (DOR), you should just overtax instead of undertax if you want to avoid fees. Great.
This hurts small development shops more than anyone. I’m sure the HPs of the world will be fine; big cap companies may have to invest quite a bit in training and accounting because of this, but they also have high-priced lawyers at their disposal who can work out the loopholes. It’s the freelancers and smaller shops who are already paying income tax on their work that will have the biggest increase in their administrative burdens, accounting costs, and liability as a percent of revenue.
And it’s not just Massachusetts developers that have to deal with this. It’s anyone who has clients who have “software” that is being “used” in Massachusetts.
“... computer software, including prewritten upgrades, which is not designed and developed by the author or other creator to the specifications of a specific purchaser. The combining of two or more prewritten computer software programs or prewritten portions thereof does not cause the combination to be other than prewritten computer software. Prewritten computer software includes software designed and developed by the author or other creator to the specifications of a specific purchaser when it is sold to a person other than the specific purchaser. Where a person modifies or enhances computer software of which the person is not the author or creator, the person shall be deemed to be the author or creator only of such person's modifications or enhancements. …”
“My accountant is tying himself in knots trying to differentiate between ‘prewritten software’ and ‘custom software.’ Is an Access database taxable? Is a MySQL database?” --Don Lesser, Pioneer Training, Inc.
As my colleague Don told me in the quote above, it will fall on our operations people to figure out how to interpret this law. We’re getting very little guidance from the people who made it.
Massachusetts lawmakers have created an FAQ which answers some of the larger questions. But unfortunately, the examples about how “Floppy Disc Co.” can navigate the laws (that’s the name of the hypothetical company, I kid you not) barely scratch the surface. We’ve created a flow chart for our clients to help them understand how this law will affect them, and we’ll keep it as up to date as we can. Here’s what (we think) we know:
- No tax for hosting.
- It doesn’t matter where you host the information. If the business you’re working for has offices in Massachusetts, you have to collect tax.
- Any work before 7/31/2013 is exempt.
- Any work contracted AND paid before 7/31/2013 is exempt regardless of whether the work has been completed.
- “Generally” troubleshooting or reinstalling existing software isn’t taxable, but if you add any new hardware or software your time is taxable.
- For clients with multiple locations, your clients can get an MPU certificate. Once they have that, you don’t have to charge them sales tax–instead, they are responsible for their own “Massachusetts portion of the use” and for filing a Massachusetts tax return.
- All sub-contractors must charge you tax and you must pass that tax on to your customers. No more burying the cost of subs in your overall project cost.
- Accountants and attorneys who use open-source or off-the-shelf software to generate tax returns or prepare documents are exempt, as is the Commonwealth of Massachusetts and the U.S. government.
- Patches and installing anti-virus software are taxable.
- If you’re based in Massachusetts and you’re working with out-of-state clients they’re exempt UNLESS they come to your office for services in which case some (all?) of your services are taxable.
- 501(c)(3) nonprofits are exempt from the tax as long as they are registered with Massachusetts and have been provided an ST-5 form from the DOR.
- If you offer a combined (taxable and non-taxable) set of services to a client, and 10% or less of the work is taxable, you are not required to collect sales tax for that total amount of work. Though this is dependant on the state’s definition of “inconsequential” serving “only as a guideline, and varies depending on the facts and circumstances of the transaction.” (See this page for more details.)
I think Bill Wilder from Coding Out Loud explained it best:
I heard back from Representative (Denise) Garlick. She’s concerned and seems her understanding of the law as written may differ from DOR interpretation. Here’s an excerpt from her email:
My understanding as I voted (Massachusetts House of Representatives) is that this proposal does not tax: Custom built computer software, data recovery services, website design, “the cloud,” or access to software hosted on a third party server.
Further, the computer services tax included in this plan does not tax: Downloaded music, books or games.
Additionally, this tax does not extend to many consumer computer services including technical support, removing software from a computer (for example, removing malware or a virus), or running diagnostics.
I think “custom built computer software” and “website design” appear (in my interpretation) to be covered as taxable in the DOR FAQ, but this contrary to Representative Garlick’s expectations when she voted for it.”
According to State Senator Stan Rosenberg (current Senate Majority Leader, and the next Senate President) the proposal came from Deval Patrick’s office and was driven by the Department of Revenue and rubber-stamped by the majority of the state legislature (35-5 and 123-33).
The implementation of tax laws rest with the Department of Revenue. They did not raise the questions being raised by the industry and their opinions drove the process. The Legislature followed the lead of the administration as it was their proposal and the Legislature believed they could implement the new tax based on the information provided by Patrick’s administration.
It is the job of the Administration to set up the rules and regulations to implement the new tax law. If they are having problems implementing it they will have to come back with recommended clarifications.
This law was finalized about a week before its implementation and it shows.
If you’re feeling perturbed, here are some things you can do:
- Sign this petition.
- Be sure to provide feedback to the people who are defining these policies and who are interpreting the law. It’s definitely worth sending them ANY fringe case you can think of to help them further define the law. The more fringe cases they have the better chance they’ll “do the right thing.”
- Call the DOR at (617-887-MDOR) and let them know what you think.
- Representative Jim Lyons (of Andover Ma) seems to be the sole voice of reason in the Mass Senate. He’s fighting this tooth and nail. Give him some love and offer your help.
- If you live or have offices in the state of Massachusetts definitely let your legislators know that you don’t approve that they rubber-stamped this.
- If you just feel like bitching, here are a few people you might want to talk to, not surprisingly we couldn’t find any of them on Twitter, and most don’t even appear to get “The Facebook”:
- Robert DeLeo
Speaker of the House
- Therese Murray
President of the Senate
- Senator Stephen M. Brewer
Chair of the Senate Committee on Ways and Means
- Representative Brian S. Dempsey
Chair of the House Committee on Ways and Means
Read this great analogy if this same law was passed for plumbers which shows why it’s such a burden on developers.