California SaaS Sales Tax Begins in 2027: What Businesses Need to Know
California businesses that purchase or sell subscription software face a significant tax change beginning January 1, 2027. Under Senate Bill 122, California will generally impose sales and use tax on qualifying prewritten computer software, including many Software as a Service (SaaS) subscriptions that were previously not subject to California sales tax.
The new law affects more than software developers and technology companies. Businesses purchasing accounting software, customer management systems, subscription applications, and other remotely accessed software may also incur additional costs or reporting obligations.
For companies selling software to California customers, the change can create new registration, tax collection, invoicing, and recordkeeping responsibilities.
The rules are particularly important for businesses operating across state lines because California sales and use tax obligations can arise even when the seller is located outside California.
Understanding these differences is an important part of broader business and multistate tax planning.
Key takeaway:
Beginning January 1, 2027, California generally treats qualifying electronically delivered and remotely accessed prewritten software as taxable tangible personal property.
Businesses selling software subscriptions to California customers should determine whether they must collect California sales or use tax. Businesses purchasing software should also review whether the vendor will collect the tax or whether the purchaser has a separate California use tax obligation.
The new law contains important exclusions, exemptions, sourcing rules, and special provisions for large software transactions.
California SB 122 Changes the Tax Treatment of Software
California enacted Senate Bill 122 on June 29, 2026, as Chapter 23, Statutes of 2026.
The legislation expands California's definition of tangible personal property for sales and use tax purposes.
Historically, California generally distinguished prewritten software delivered on physical media from software transferred electronically or accessed remotely.
A qualifying sale of prewritten software on physical media could be taxable, while electronically delivered software often was not.
SB 122 changes that distinction beginning January 1, 2027.
Under the new law, the method of delivering or accessing qualifying prewritten software generally no longer determines whether the transaction is taxable.
Revenue and Taxation Code Section 6016 expands the definition of tangible personal property to include qualifying digital products and associated copyright or patent interests.
Section 6016.1 defines the digital products covered by the legislation.
The statutory changes are supported by the California Department of Tax and Fee Administration's Tax Guide for Retailers and Purchasers of Digital Products.
What Software Becomes Taxable in California in 2027?
The central concept is whether the transaction involves qualifying prewritten computer software.
Prewritten computer software generally means software held or existing for general or repeated sale or lease.
Software does not necessarily become custom software merely because it was originally developed for a particular customer or was initially created for internal use.
The new definition generally includes:
- Prewritten computer software delivered on physical storage media.
- Prewritten software downloaded electronically.
- Prewritten software accessed remotely through the internet.
- Subscription software accessed through a web browser.
- Qualifying hosted applications accessed through a program interface.
- Other software arrangements meeting the statutory definition of a digital product.
For example, a business purchasing access to a standard cloud accounting application may be purchasing a taxable digital product beginning in 2027, even though the business does not receive a physical copy of the software.
The classification depends on the actual product, contractual rights, and applicable statutory exclusions.
Not Every Digital Product or Online Service Is Taxable
Although SB 122 significantly expands California's sales tax base, it does not impose sales tax on every product or service delivered over the internet.
The statute expressly excludes several categories from its definition of taxable digital products.
| Product or service | General California treatment beginning in 2027 |
|---|---|
| Prewritten software downloaded electronically | Generally taxable when sold or purchased for taxable use in California. |
| Qualifying SaaS subscriptions | Generally taxable when the customer obtains access to the provider's prewritten software. |
| Custom computer software | Generally excluded from tax when the transaction satisfies the applicable custom software requirements. |
| Cloud infrastructure | Excluded when the service meets the statutory definition of digital infrastructure. |
| Digital books, music, and audiovisual works | Generally excluded from the statutory definition of digital products. |
| Digital assets | Excluded from the new digital product definition. |
| Qualifying services primarily involving human effort | May be exempt when the applicable statutory requirements are satisfied. |
| Software purchased solely for qualifying use outside California | May qualify for an interstate or foreign commerce exemption. |
These descriptions address the general rules. Transactions involving multiple products, bundled services, licensing arrangements, or mixed uses may require a more detailed analysis.
Custom Computer Software
California generally continues to exclude qualifying custom computer software from sales and use tax.
Custom software generally means software prepared to the special order of a single customer.
Separately stated charges for qualifying modifications to existing prewritten software may also receive custom software treatment.
However, the fact that a vendor configures standard software for a particular customer does not automatically make the entire transaction exempt.
The distinction between the existing prewritten software and qualifying custom modifications must be supported by the facts and contract documentation.
Cloud Infrastructure
The law also excludes certain digital infrastructure services.
This generally includes qualifying cloud infrastructure that allows customers to create, deploy, scale, or run their own applications on a provider's platform.
The California Department of Tax and Fee Administration identifies qualifying Infrastructure as a Service and Platform as a Service arrangements as examples.
However, a provider may sell several different services, some of which qualify as excluded infrastructure while others provide taxable access to prewritten software.
The classification should therefore be determined by product rather than assuming every service purchased from a particular cloud provider receives the same treatment.
Professional Services and Other Human Services
SB 122 also preserves an exemption for qualifying services provided electronically when the services primarily involve human effort originating after the customer's request.
This distinction can be important for consulting, professional services, and other arrangements involving substantial human services.
However, the exemption does not apply merely because a subscription software provider describes its product as a service.
Access to the provider's prewritten computer software through a browser or program interface may still constitute a taxable software transaction.
California Businesses Purchasing SaaS May Pay More Beginning in 2027
For many businesses, the most immediate consequence will be an increase in the cost of software subscriptions.
A California business may currently purchase several cloud applications without a separately stated California sales tax charge.
Beginning in 2027, a vendor may be required to collect applicable California sales or use tax on subscriptions that meet the new definition of taxable software.
The additional tax can affect:
- Accounting and bookkeeping software subscriptions.
- Customer relationship management applications.
- Project management and business operations software.
- Payroll and human resources applications.
- Business productivity applications.
- Other standard subscription software accessed remotely.
These examples are not determinations that every product within the category is taxable.
The product's actual functions, contractual terms, and applicable exemptions must be considered.
Businesses should review recurring subscription expenses and identify which vendors may begin collecting California sales or use tax in January.
For businesses using substantial amounts of software, the combined increase in annual operating expenses may be meaningful.
California Use Tax May Apply Even When the Vendor Does Not Collect Tax
Businesses should not assume that a software purchase is exempt simply because the vendor does not charge California sales tax.
California use tax can apply to taxable digital products purchased from retailers for storage, use, or other consumption in California.
A purchaser may be responsible for reporting and paying the use tax directly to the California Department of Tax and Fee Administration when:
- The seller is located outside California and is not required to collect California use tax.
- The seller is registered but fails to collect the applicable tax.
- The purchaser claims an exemption but subsequently makes a taxable use of the software.
- The transaction falls within special provisions shifting tax responsibility from the retailer to the purchaser.
This means that businesses purchasing software from out of state vendors should review the invoices and determine whether California use tax must be accrued.
The CDTFA addresses these responsibilities in its guidance for purchasers of digital products.
Out of State SaaS Sellers May Have California Tax Obligations
SB 122 is particularly relevant for businesses selling software subscriptions to California customers from another state.
A company does not necessarily need a California office to have a California sales or use tax collection obligation.
Under Revenue and Taxation Code Section 6203, a retailer can be considered engaged in business in California through specified physical activities or by exceeding the applicable economic nexus threshold.
For certain remote sellers, the economic nexus threshold generally applies when combined sales of tangible personal property for delivery in California by the retailer and related persons exceed $500,000 during the preceding or current calendar year.
Beginning in 2027, qualifying software sales are included within the expanded tangible personal property framework.
Therefore, software sellers that previously had no California sales or use tax collection obligation may need to reevaluate their status.
Important distinction:
The $500,000 economic nexus threshold is not an exemption from tax for every business with sales below that amount.
A retailer with a California physical presence or another statutory connection to the state may have a collection obligation even when its sales are below $500,000.
Likewise, a purchaser's use tax obligation can exist independently of whether the seller is required to collect the tax.
The interaction between the new software classification and the preceding calendar year economic nexus calculation may require additional administrative clarification for some businesses entering 2027.
Businesses near the threshold should evaluate their customer activity and registration status before January 1 rather than assuming that prior treatment of software subscriptions will continue.
California Sales Tax and Income Tax Nexus Are Different Questions
A business selling software to California customers may have several distinct state tax obligations.
California sales and use tax obligations are governed by the California Sales and Use Tax Law.
California income and franchise tax obligations are governed by separate statutes, including rules addressing business activity, economic nexus, apportionment, and income sourcing.
Consequently, determining whether a software seller must collect California sales tax does not necessarily resolve whether the business or its owners must file California income tax returns.
For business owners operating in multiple states, these issues should be evaluated separately.
For additional discussion of income taxation, see California tax planning for business owners with multistate income.
Customer Location Will Affect California Software Sales Tax
SB 122 establishes specific sourcing rules for digital products transferred electronically or accessed remotely.
For certain remote sales, the place of sale is generally determined using the purchaser's known California address maintained in the seller's ordinary business records.
When multiple addresses are provided during the transaction, the statutory rules establish an order of priority.
The CDTFA identifies the following hierarchy:
- The purchaser's billing address.
- The shipping or delivery address.
- The mailing address associated with the payment instrument.
- The purchaser's mailing address.
If no qualifying address is provided during the transaction, the seller may need to use the most recent previously provided California address under the applicable rules.
If no California address is available, the sale may be treated as occurring outside California for the relevant sourcing determination.
However, determining the place of sale and determining whether a purchaser owes California use tax are separate questions.
A business should not assume that using an out of state billing address automatically eliminates use tax when employees access or use the software in California.
Software Used in Several States Requires Special Attention
The sourcing rules become more complicated when a business purchases software for employees located in multiple states.
For example, a company headquartered in Texas may purchase a single enterprise software subscription used by employees in Texas and California.
The seller's records may identify one billing address, while individual users access the software from several states.
California's use tax rules can consider where the relevant rights or powers over the digital product are exercised.
The legislation provides rules addressing qualifying purchases solely for use outside California and certain transactions involving both California and out of state use.
A business may need to retain records establishing where the software is actually used.
The CDTFA's current guidance permits specified allocation treatment for certain mixed use transactions and states that it may authorize or require alternative methods when supported by records and when they fairly reflect the tax due.
This should not be interpreted as a blanket right to allocate every enterprise software subscription using any method chosen by the purchaser.
The applicable transaction structure, exemption requirements, documentation, and further administrative guidance must be considered.
The $5 Million Rule Can Shift Tax Reporting to the Purchaser
One of the more unusual provisions of SB 122 concerns large transactions involving digital products.
Revenue and Taxation Code Section 6052 establishes circumstances in which the retailer can be relieved of the liability to pay sales tax or collect use tax on qualifying digital product transactions.
For 2027, the rule generally becomes relevant when a retailer's aggregate gross receipts from electronically transferred or remotely accessed digital products sold to the same purchaser exceed $5 million during the calendar year.
Beginning in 2028, the rule generally considers whether the threshold was exceeded during the current or preceding calendar year.
The threshold is subject to statutory inflation adjustments.
When the provision applies, the purchaser may become responsible for reporting and paying the applicable use tax directly to the CDTFA.
The purchaser generally must obtain a Use Tax Direct Payment Permit and provide the appropriate exemption certificate to the retailer.
The CDTFA explains that the purchaser's responsibility can begin with the transaction that causes the threshold to be exceeded.
This is not a $5 million exemption from taxation.
Rather, it establishes a mechanism for shifting responsibility for payment and reporting.
Special exceptions apply, including provisions involving insurance companies and circumstances in which the CDTFA may waive the purchaser's direct payment requirements.
As of October 2026, the CDTFA is developing emergency regulations to clarify the direct payment and waiver procedures.
Businesses anticipating transactions near this threshold should monitor the final administrative procedures rather than assuming that the vendor must automatically stop collecting tax without the appropriate documentation.
Does the New Tax Apply to Existing Software Contracts?
The January 1, 2027 effective date creates potential issues for subscription agreements signed before the new law was enacted.
For example, a business may have entered into a multiyear software agreement in 2026 with pricing based on the prior California tax treatment.
The contract may remain in effect during 2027 and later years.
Businesses should review the contractual tax provisions, payment schedules, renewal terms, and nature of the software rights being provided.
A contract signed before January 1, 2027 does not automatically exempt every transaction occurring after the new law becomes operative.
However, it would also be incorrect to assume that every payment received in 2027 under an older agreement is taxable without considering the timing and legal characterization of the underlying transaction.
The applicable sales and use tax treatment depends on the facts and relevant statutory provisions.
Vendors should determine whether existing agreements permit applicable sales tax to be charged separately or whether the contract price includes tax.
Purchasers should review whether vendors may increase subscription invoices to recover the additional tax.
Example: A Business Purchasing Software From an Out of State Vendor
Assume the following:
- A California business purchases an annual subscription to standard cloud accounting software.
- The software is accessed remotely through a web browser.
- The vendor is located outside California.
- The subscription is renewed during 2027.
- The software does not qualify for a statutory exclusion or exemption.
Beginning in 2027, the subscription generally falls within California's expanded definition of taxable digital products.
If the vendor is required to collect California use tax, the purchaser may see a new tax charge on its subscription invoice.
If the vendor is not required to collect the tax and does not do so, the California business may be responsible for reporting and paying the use tax directly.
The analysis requires determining the correct transaction classification, applicable location, tax collection responsibility, and rate.
The example illustrates why purchasers should review recurring software expenses instead of assuming that the vendor's invoice necessarily reflects every applicable California tax obligation.
What Businesses Should Do Before January 1, 2027
Businesses affected by SB 122 should review their existing software transactions before the effective date.
For Software Sellers
- Identify products that qualify as taxable prewritten software.
- Separate potentially exempt custom software or other qualifying services.
- Determine whether the company has California physical or economic nexus.
- Review California customer addresses and applicable sourcing rules.
- Determine whether a California seller's permit or use tax registration is required.
- Review invoicing and billing systems for applicable California tax collection.
- Evaluate contracts that continue into 2027.
- Identify large customers potentially subject to the $5 million direct payment provisions.
- Retain records supporting product classifications, exemptions, and taxable sales.
For Businesses Purchasing Software
- Identify recurring software subscriptions and other digital products.
- Determine which products may become taxable in 2027.
- Review whether vendors will collect California sales or use tax.
- Identify purchases requiring separate use tax reporting.
- Document software used solely outside California when claiming the applicable exemption.
- Review subscriptions used by employees in multiple states.
- Update budgets for possible increases in software costs.
- Review contracts for sales tax reimbursement provisions.
Businesses with multiple locations or substantial subscription expenses may benefit from reviewing these items together rather than addressing each software invoice independently.
Additional CDTFA Regulations Are Expected
The new California software tax is enacted law.
However, the California Department of Tax and Fee Administration has not completed every aspect of its administrative implementation.
The CDTFA's current guidance specifically states that emergency regulations are being drafted to interpret and clarify provisions of SB 122.
These regulations are expected to address matters involving the special direct payment provisions and related administrative procedures.
Businesses should distinguish the enacted statutory requirements from administrative procedures that remain under development.
The current CDTFA guidance should also be reviewed before finalizing registration, reporting, or exemption procedures for 2027.
Final Takeaway
California's decision to tax qualifying electronically delivered and remotely accessed software beginning January 1, 2027 represents a significant change for businesses operating in the state.
Software vendors may face new California registration, collection, and reporting obligations.
Businesses purchasing software may incur additional costs or become responsible for reporting California use tax when the vendor does not collect it.
The rules are particularly important for businesses operating across state lines, purchasing software for employees in several locations, or entering into long term software subscription agreements.
The law also contains meaningful exclusions and special rules that require attention before a transaction is classified as taxable.
Business owners should review their software transactions, contracts, and existing tax obligations before the January 1, 2027 effective date rather than relying on the previous California treatment of software subscriptions.
