As Software as a Service (SaaS) becomes an increasingly common part of business-as-usual, legislatures and tax authorities are trying to figure out how to govern this unusual type of product. Existing rules currently vary widely from place to place. And the question of how to define and tax the broad and emerging categories within the vast digital space is quickly becoming a hot topic within state and local tax.

This is because, as Pillsbury Law puts it, “most cloud computing offerings do not fit neatly into traditional state tax categories.”

As jurisdictions work to make up new rules or categories that can fit SaaS, conflicts inevitably arise. This is particularly the case with home rule cities, in which local tax authorities manage municipal or city sales tax independent of the state department of revenue.

One such city is Chicago. Let’s look at why some cities are tricky for SaaS taxation and how this plays out in the Windy City.

What are home rule cities? Why are they tricky for SaaS?

Home rule cities are those that have local self-governance under a “home rule charter” that lays out their preferred form of municipal government, size of and rules for city council, electoral policies for the mayor’s seat, and the specifics of boards and commissions.

In terms of sales tax administration, a home rule city may have a self-administered local taxing authority that manages taxability, collection, and compliance separate from state authorities. This means that city rules can be different from state rules. Such cities may have their own sales tax return that differs from the state return, as well as different filing frequency and payment requirements.

The biggest difference of all tends to be that of taxability. In non-home rule cities, taxability follows the state. For example, the state of Pennsylvania taxes software and has a state-wide rate of 6%. The city of Philadelphia in Pennsylvania can add its own tax rate of 2%, but the taxability of the products themselves follows that of the state (i.e., software is also taxable in the city). In home rule cities, the city can decide to tax software even if the state does not.

In 2018, when the U.S. Supreme Court’s South Dakota v. Wayfair decision expanded states’ ability to require out-of-state sellers to collect sales and use tax, many SaaS providers suddenly had to contend with new jurisdictions in which they were liable to handle sales tax. Home rule cities can now require these sellers to collect sales tax on SaaS sales—often lumped under categories like “software,” “information services” or “data processing services”—even if the states in which they were located do not tax SaaS.