California has taken a significant step in modernizing its tax code. With the signing of Senate Bill 122 (“SB 122”) as part of the state’s 2026-2027 budget, Governor Gavin Newsom expanded California’s sales and use tax rules to apply to prewritten computer software delivered electronically or accessed remotely, including many software-as-a-service (SaaS) offerings. The change takes effect January 1, 2027, and California expects the legislation to generate substantial new state and local tax revenue annually. For businesses that operate in California, sell to customers in the state, or purchase software or technology solutions for use by California-based employees, this is not a distant policy change but an operational reality that warrants attention now.

What Is Changing Under California SB 122

Historically, California’s sales tax applied to tangible personal property, items that could be physically seen or touched. Electronically delivered software and cloud-based access generally fell outside that definition. SB 122 largely removes the historical distinction based on how prewritten software is delivered. Beginning January 1, 2027, prewritten software is treated as taxable tangible personal property whether it is delivered on a physical disc, downloaded electronically, or accessed remotely through a browser or application interface. Many SaaS platforms, enterprise software subscriptions, and hosted applications may become subject to California sales and use tax under SB 122, though certain exclusions, exemptions, and fact-specific considerations may continue to apply.

Not everything is swept into the new tax. Custom software, certain categories of digital content, and services that primarily involve human effort generally remain outside the scope of the new law. However, the treatment of some product categories, particularly those that blend software access with service delivery, remains uncertain and will likely depend on future California Department of Tax and Fee Administration (“CDTFA”) guidance and interpretation. Businesses operating in these gray areas should closely monitor developments as implementation approaches.

Why This Matters for Businesses

Businesses can no longer rely on the position that cloud-based software and SaaS subscriptions fall outside California’s sales and use tax base. The compliance implications are broad. Businesses will need to evaluate the taxability of their software purchases and subscriptions, review vendor and customer contracts to determine responsibility for tax collection and remittance, and assess whether use tax self-accrual obligations apply. The sourcing rules introduced by SB 122 also place new importance on the accuracy of customer and vendor address data, and businesses with distributed workforces or multi-state operations will face additional considerations in determining their California tax exposure.

SB 122 also introduces special compliance requirements for certain high-volume purchasers of digital products and software. Businesses exceeding a $5 million annual threshold may be responsible for reporting and remitting the applicable tax directly rather than relying on the seller to collect it, making proactive transaction tracking and documentation essential. 

These are not simple determinations, and getting them wrong, particularly in the early months of enforcement, carries real audit risk. Businesses should begin evaluating the potential impact of SB 122 now rather than waiting for implementation guidance to be finalized.

Act Now: January 2027 Is Closer Than It Looks