Yes, software is generally subject to sales tax in Texas, but how much you owe depends on what kind of software it is and how it’s delivered. Prewritten software is taxed at the full combined rate of up to 8.25%. Software as a Service is taxed as a data processing service, with 20% of the price exempt. Software built from scratch for a single customer can be exempt entirely if the contract is structured correctly.
Prewritten Software Is Fully Taxable
Off-the-shelf software, sometimes called canned software, is taxable whether you buy a physical copy, download it, or receive it on a flash drive. Texas defines a computer program as a series of instructions coded for use by a computer system, and the sale, lease, or license of that program counts as a sale of tangible personal property.1Cornell Law School. 34 Texas Admin Code 3.308 – Computers-Hardware, Computer Programs, Services, and Sales The delivery method is irrelevant. A downloaded copy of accounting software is taxed the same as a boxed one.
The tax applies to the full purchase price, including any separately stated charges for installation or setup that are part of the same transaction. The combined state and local rate in Texas can reach 8.25%, made up of a 6.25% state rate plus up to 2% in local taxes.2Texas Comptroller. Sales and Use Tax On a $10,000 enterprise license, that’s up to $825 in tax.
Common examples in this category include office productivity suites, accounting packages, antivirus programs, and design tools. Anything designed for general use and sold to multiple customers without substantial modification lands here.
SaaS and Cloud-Based Software Get a 20% Break
When you access software through a browser or app instead of installing it on your own machine, Texas treats the transaction as a taxable data processing service. The regulation defines data processing broadly, covering computerized entry, retrieval, search, compilation, manipulation, or storage of data, along with internet hosting where you use the provider’s hardware or software.3Cornell Law School. 34 Texas Admin Code 3.330 – Data Processing Services
The good news is a built-in partial exemption. Texas Tax Code Section 151.351 exempts 20% of the value of data processing services from sales tax, so you only pay tax on 80% of your SaaS bill.4State of Texas. Texas Tax Code Section 151.351 – Information Services and Data Processing Services On a $1,000 monthly subscription at the maximum 8.25% rate, you’d owe tax on $800, bringing the tax to $66 instead of $82.50. The exemption applies automatically. You don’t file anything or submit a certificate to claim it.
One catch: if the same service is also taxable under another category besides information services, the 20% exemption disappears.3Cornell Law School. 34 Texas Admin Code 3.330 – Data Processing Services Bundled products that mix data processing with a separately taxable service can lose the break entirely.
Custom-Built Software Can Be Exempt
Software designed and developed from scratch for one customer is treated as a nontaxable service rather than tangible personal property. This is where the biggest savings live, but the conditions are strict. The developer must transfer all rights to the finished program to the customer. If the developer keeps any right to reuse, resell, or adapt the code for other clients, the Comptroller can reclassify the deal as a taxable sale of prewritten software.1Cornell Law School. 34 Texas Admin Code 3.308 – Computers-Hardware, Computer Programs, Services, and Sales
In practice, the exemption is narrower than it sounds. A developer who takes an existing code framework and tailors it to your business has not built custom software from scratch. The program has to be written specifically for you, and you need to own it outright once the work is done. Plenty of contracts that look custom on the surface fail this test because the developer retains licensing rights to the underlying architecture.
Maintenance and Support Contracts
Software maintenance agreements that include future updates or upgrades to prewritten software are generally taxable in Texas, because the updates themselves are transfers of tangible personal property. A contract that only provides technical support without delivering new code is different territory, since the support piece is a service rather than a product transfer.
Bundling is where buyers get hurt. When one agreement covers both software updates and technical support without separately itemizing each charge, the entire contract price can become taxable. If your vendor breaks out support on a separate line from software updates, you may only owe tax on the update portion. Over a multi-year contract, the difference adds up.
Resale and Manufacturing Exemptions
Software purchased for resale is exempt from sales tax. To qualify, you give the seller a completed Texas Sales and Use Tax Resale Certificate (Form 01-339) at the time of purchase. If you later use the software yourself instead of reselling it, you owe tax on that use.
Software used directly in manufacturing may also qualify for an exemption under Texas Tax Code Section 151.318. The exemption covers tangible personal property directly used or consumed during the actual manufacturing, processing, or fabrication of goods for ultimate sale, where that use is necessary or essential to the operation.5State of Texas. Texas Tax Code Section 151.3181 – Divergent Use of Property Used in Manufacturing Programs that directly control production equipment or manage fabrication processes can qualify. If you start using the software for non-manufacturing purposes within four years of purchase, you may owe tax on the months of non-qualifying use.
Buying from Out-of-State Vendors
Out-of-state software companies aren’t automatically off the hook. Under Texas economic nexus rules, a remote seller must obtain a Texas sales tax permit and start collecting once its total Texas revenue exceeds $500,000 in the prior 12 calendar months.6Texas Comptroller. Remote Sellers and Marketplace Frequently Asked Questions Larger vendors collect Texas tax at checkout. Smaller ones often don’t.
When you buy taxable software from a vendor that doesn’t collect Texas tax, you owe use tax directly to the state. Use tax mirrors the sales tax rate and applies to taxable items purchased outside Texas for use inside the state.7Texas Comptroller. Online Orders – Texas Purchasers and Sellers Shipping and handling are included in the taxable amount. If you hold a Texas sales tax permit, you report use tax on your regular return under “taxable purchases.” If you don’t have a permit, you file a separate use tax return with the Comptroller.
This trips up businesses that subscribe to cloud software from vendors in states with no sales tax. The vendor’s home state is irrelevant. If the software is used in Texas, Texas wants its tax.
What Happens If You Get It Wrong
Texas imposes escalating penalties when sales tax isn’t filed or paid on time:
- 1 to 30 days late: 5% penalty on the tax due
- More than 30 days late: 10% penalty
- After the date on a Notice of Tax Due: an additional 10% penalty, bringing the total to 20%
The Comptroller also charges a $50 late-filing fee for each delinquent report, even if no tax was due for that period. Statutory interest starts accruing on the 61st day after the report’s due date, at a variable rate the Comptroller sets each calendar year.8Texas Comptroller. Penalties for Past Due Taxes
If your business has been selling or buying software in Texas without handling sales tax correctly, the Comptroller’s Voluntary Disclosure Program offers a way to fix it with reduced consequences. Statutory penalties and interest are waived in most cases, except for interest on taxes actually collected from customers but never sent to the state.9Texas Comptroller. Voluntary Disclosure Program
To qualify, your business can’t already have been contacted by the Comptroller about the liability, and you can’t be under audit for the tax type you’re disclosing. The Comptroller limits its review to reports due within four years of your initial contact, though there’s no lookback limit for taxes collected from customers but never remitted. Once an agreement is reached, you have 60 days to submit the tax data and payment.9Texas Comptroller. Voluntary Disclosure Program For a software company that recently crossed the nexus threshold, or a buyer that treated SaaS as nontaxable for years, disclosure before the Comptroller comes calling is almost always the cheaper move.