Alabama Supreme Court Holds That Custom Software Is Taxable

June 25, 2019

The Alabama Supreme Court ruled that custom software is taxable (reversing over 20 years of guidance from the state) and that certain software services may be nontaxable if separately stated.

By Tina M. Chunn, SALT Senior Manager

Software has often been a confusing product when determining whether sales tax will apply in each state, since taxability may be determined based on differing interpretations of the software product itself and the manner in which the software is provided.  In most states, two issues must typically be addressed to decide whether software is taxable.  First, is the software written for and provided to a specific customer (i.e., custom) or is it written for and provided to multiple customers (i.e., canned/prewritten)?  Generally, custom software is considered a nontaxable service, whereas canned software may be taxable based on how it is delivered.[1]

Second, is the software delivered on a tangible medium (e.g., flash drive), is it electronically downloaded, or is it accessed remotely (e.g., SaaS).  Generally, states view software provided via a tangible medium as being taxable as tangible personal property; however, the taxability of electronically downloaded or remote access software differs by state.  Ultimately, for software to be taxable, both the type (i.e., custom vs. canned) and the manner of delivery (i.e., tangible medium vs. electronic download vs. remote access) must be taxable.

On May 17, 2019, the Alabama Supreme Court issued an opinion affirming the lower court’s ruling that the sale of custom software is subject to sales tax.[2]  This ruling is significant in that it directly contradicts Alabama’s long-standing position based on existing guidance for over 20 years providing that canned computer software is subject to tax as tangible personal property and that custom software is not subject to tax because it represents a service and not tangible personal property.[3]

The taxpayer is a hospital that contracted with a healthcare management company to provide the hospital with various computer software programs and accompanying equipment.  As part of the implementation of the software, the vendor performed software configurations to the specific needs of the customer based on how it needed the software to function.[4]  Sales tax was paid to the company on these transactions, and then the hospital and company jointly petitioned the state for a refund claiming that the purchases were for nontaxable custom software.  The claim was denied, and the parties’ dispute ultimately made its way to the Alabama Supreme Court.

The Court concluded that all software is tangible personal property for Alabama sales tax purposes, whether it is canned software or custom software created for a particular user.  On the other hand, services to design, program, or modify software, as well as to install software or train users on the software will remain nontaxable, if separately stated.  However, the charges for the software itself are to be considered a taxable sale.  As the opinion states:

The pertinent distinction is how the transaction is documented and invoiced, and that is left strictly in the hands of the seller and purchaser. To the extent a seller tenders an invoice for computer software, the gross amount allocated to that software is subject to sales tax. However, a seller’s invoice for services such as those identified above, when separately stated, is not subject to sales tax.

At this time, the Department has not issued any specific guidance as a result of this opinion, including the extent to which it may apply this decision retroactively. However, on June 19, 2019, the Alabama Department of Revenue issued a brief notice in which it stated:

The department is undertaking a review of its related administrative rules, which will be updated to ensure that the terminology used to demonstrate this distinction is consistent with that used by the Court in the Ex parte Russell County decision.

In the meantime, taxpayers should review their software transactions to make sure that the proper amount of sales tax is being collected.  Aprio’s SALT team has experience with these types of transactions and can work with companies to review and make recommended changes to invoices and documentation to ensure that any nontaxable services are properly accounted for in contracts and on invoices.  We constantly monitor these and other important state tax topics, and we will include any significant developments in future issues of the Aprio SALT Newsletter.

Contact Tina Chunn at or Jeff Glickman, partner-in-charge of Aprio’s SALT practice, at for more information.

This article was featured in the June 2019 SALT Newsletter.

[1] It is worth noting that the rules discussed in this article are not uniformly applied by all states.

[2] Ex parte Russell County Community Hospital, LLC, d/b/a Jack Hughston Memorial Hospital v. Alabama Department of Revenue, No. 1180204 (Ala. S.Ct. May 17, 2019).

[3] Ala. Admin. Code, Reg. 810-6-1-.37; Wal-Mart Stores, Inc. v. City of Mobile, 696 So. 2d 290 (Ala. 1996).

[4] The opinion did not provide clarify on the exact amount of configuration/customization provided.

Any tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or under any state or local tax law or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein. Please do not hesitate to contact us if you have any questions regarding the matter.

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About the Author

Tina Chunn

Tina is a senior manager with Aprio’s State & Local Tax group. She has over 24 years of experience assisting companies and their owners to minimize their tax liability and maximize their profitability. Some of the industries Tina serves include professional services, manufacturing, warehousing and distribution, telecommunications, real estate, retailers and wholesalers. Tina has extensive experience dealing with corporate tax issues, including state and local tax returns; state and federal tax credits; state and local sales; and use, income, escheat, business licenses and property tax issues.