California has historically treated software differently depending on how it was delivered. While prewritten software sold on physical media generally has been taxable, software delivered electronically and Software-as-a-Service (SaaS) arrangements have largely remained outside California's sales and use tax base. That will change beginning January 1, 2027.
On June 29, 2026, Governor Gavin Newsom signed California Senate Bill 122 (SB 122), significantly expanding the state's sales and use tax rules to include prewritten computer software regardless of how it is delivered or accessed.[1] As a result, many software subscriptions, cloud-based applications, and SaaS offerings will become subject to California sales and use tax for the first time.
California's New Approach to Software Taxation
SB 122 expands California's definition of taxable property to include digital products, including prewritten computer software delivered through physical media, electronic download, or remote access platforms.[2] The legislation aligns California with many other states that already tax SaaS and electronically delivered software.
Beginning January 1, 2027, businesses purchasing or selling software for use in California may be subject to state and local sales and use tax obligations regardless of the software delivery method.[3] California's statewide sales tax rate remains 7.25%, with additional local district taxes potentially increasing the effective rate depending on the customer's location.
What Will Become Taxable?
Under SB 122, taxable software generally includes:
The legislation reflects California's recognition that software is increasingly accessed digitally rather than installed locally.
Important Exceptions
Not all digital products will become taxable.
Custom software developed specifically for a customer's unique requirements generally remains exempt from sales and use tax.[5] In addition, SB 122 excludes certain categories of digital products, including various digital media products, digital books, streamed content, digital assets, and certain digital infrastructure services.
Because the distinction between custom and prewritten software can be highly fact specific, businesses should carefully review software offerings, licensing arrangements, and service agreements to determine the proper tax treatment.
New Sourcing Rules and Collection Obligations
The legislation establishes sourcing rules to determine where software transactions are taxable. Generally, transactions will be sourced based on the purchaser's address contained in the seller's records, using a hierarchy of customer address information when multiple addresses exist.[6]
SB 122 also includes a noteworthy compliance provision for large purchasers. In certain circumstances involving more than $5 million of annual purchases from a retailer, responsibility for remitting use tax may shift from the seller to the purchaser.[7] This rule may reduce collection burdens for retailers while increasing compliance responsibilities for large enterprise buyers.
What This Means for Businesses
The new legislation creates significant planning and compliance considerations for both software vendors and software purchasers.
Businesses should consider:
For multistate businesses, the legislation may also create additional complexity because California's allocation and multiple-points-of-use provisions are more limited than those available in some other states that tax software and SaaS.
Looking Ahead
California's decision to tax SaaS and remotely accessed software represents one of the most significant state sales tax developments affecting technology companies and software users in recent years. As businesses prepare for the January 1, 2027 implementation date, early planning may help reduce compliance risks and avoid operational disruptions once the new rules take effect.
Have Questions or Need Guidance?
Businesses that sell software into California or purchase software and SaaS solutions for California operations should consider assessing the potential impact of SB 122 now. Proper classification of software products, sourcing determinations, contract language, and tax collection procedures will become increasingly important as the effective date approaches.
If you have questions regarding California's new taxation of software and SaaS or how these changes may affect your business, please contact your HCVT advisor.
[1] Cal. SB 122 (2026), amending Rev. & Tax. Code §§ 6006, 6009, 6010, and adding §§ 6016.1 and 6016.2; Chapter 23, Statutes of 2026. [2] Cal. Rev. & Tax. Code § 6016.1. [3] Cal. Rev. & Tax. Code §§ 6006(h)-(i), 6009(b). [4] Cal. Rev. & Tax. Code §§ 6006(h)-(i). [5] Cal. Rev. & Tax. Code § 6016.1(b). [6] Cal. Rev. & Tax. Code §§ 7202.1 and 7254. [7] Cal. Rev. & Tax. Code §§ 6052 and 6201.55.
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