Boost compliance and help reduce exposure by understanding AI SALT impacts

When developing artificial intelligence (AI) software and operating in various jurisdictions, AI companies must pay close attention to state and local tax considerations to be compliant and reduce risk.

AI companies should be aware that generating revenue from inbound sales into jurisdictions outside the company’s home jurisdiction may have incremental state and local tax consequences for sales and use tax, income tax, franchise tax, and gross receipts tax. In addition, the presence of remote employees may create personal income tax withholding and payroll tax issues.

Because AI companies may deliver products and services through multiple mediums, the consequences can be complicated. Constant changes in state and local taxation mean AI companies need to carefully consider tax implications.

AI companies must remain vigilant in understanding the multifaceted tax landscape that affects their operations. By proactively assessing their tax obligations across various jurisdictions, they can mitigate risks and maintain compliance in an evolving regulatory environment. Staying informed about tax implications is crucial for sustainable growth and success.

AI companies: Navigating state and local tax considerations

As AI companies expand their reach beyond their home jurisdictions, they must navigate a complex landscape of state and local tax implications. Revenue generated from sales in various jurisdictions can trigger obligations for sales and use tax, income tax, franchise tax, and gross receipts tax.

Additionally, the presence of remote employees can complicate payroll tax responsibilities.

The complexity of tax guidance

The innovative nature of AI services means that tax guidance is continually evolving. Inconsistent treatment across jurisdictions regarding the taxability of AI products complicates the determination of nexus — the legal connection that allows a state to impose tax obligations on a business.

Payroll tax considerations

With the rise of remote work, AI providers must also consider payroll tax implications. States may impose income tax on remote employees based on where they work, leading to potential liabilities for employers.

Emerging AI-specific tax regulations

As AI becomes more prevalent, some states and localities are beginning to explore AI-specific taxes or fees. For example, there have been discussions about taxing AI usage or its impact on local labor markets. AI companies should stay informed about legislative developments and participate in industry advocacy efforts to share fair and reasonable tax policies.

Nexus standards

Nexus can be established through physical presence, for example office locations or places where employees work, or economic presence, which has gained prominence following the 2018 Supreme Court ruling in South Dakota v. Wayfair, Inc. This ruling allows states to impose sales tax on businesses without a physical presence if they exceed certain sales thresholds, typically $100,000 in sales or 200 transactions.

However, the thresholds and definitions of taxable sales vary significantly by state.

Income tax implications

For income tax purposes, nexus can be established through:

• Physical presence
• Economic nexus
• Factor-presence nexus

The apportionment of income to specific jurisdictions is determined by various methodologies, including single sales factor and three-factor formulas. The classification of AI services — whether as tangible personal property or a service — can significantly impact tax obligations.

Sales tax considerations

AI providers must understand how their products are classified for tax purposes. The medium of delivery — whether through software applications, cloud-based services, or other means — affects taxability.

For instance, while many states tax AI solutions delivered on tangible media, the treatment of AI services varies widely. Some states impose sales tax on AI services, while others do not, leading to potential compliance challenges.

Exemptions and sourcing

Certain jurisdictions offer exemptions for AI solutions used in manufacturing or research and development.

Additionally, sourcing rules dictate where sales tax is applied, which can be complicated by the use of AI across multiple jurisdictions. Providers must be diligent in collecting exemption certificates and understanding the implications of multiple points of use.