Vital News: California To Tax SaaS Soon

About half of U.S. states impose sales tax on software as a service (SaaS) and other digital products in some form — and this isn’t a matter of high-tax “blue” versus low-tax “red” states. On June 29, 2026, California joined the crowd when Governor Gavin Newsom signed California Senate Bill 122 (SB 122) into law. Effective 2027, SB 122 broadens California’s existing sales and use taxes to cover SaaS and similar downloadable software products. It also carves out some important exceptions and lays down rules for figuring when a software sale is taxable in California and when it isn’t. The California Department of Tax and Fee Administration (CDTFA), which runs the state’s sales and use tax system, still needs to flesh out the details over the coming months. Software vendors should start planning how to comply with SB 122 now — not wait until New Year’s Day 2027.

Background

California’s sales and use taxes apply when one sells “tangible personal property” or brings it into California. A California business pays sales tax on gross receipts from in-state sales, and a customer pays use tax on an item’s value if the customer buys it outside California and then brings it to the state. While California vendors can pass sales tax through to customers as a reimbursement, the vendor keeps the obligation to report and pay sales tax.

Figuring out what counts as “tangible personal property” has always been tricky for software and other digital products. During the last 40 years, retail purchases have moved from “shrink-wrap” boxes to a single card with a QR code or unique password to download software online. The CDTFA tried to clarify through rules, but the guidance didn’t keep up with technology and often just added to the confusion. In any event, California did not impose sales or use tax on “pure” remote-access or electronically-delivered software, and many California-based software companies ended up with little or no sales tax exposure across the U.S. and lobbied hard to keep it that way.

Enter Senate Bill 122

SB 122 “does a 180” by extending “tangible personal property” to cover “digital products”, including SaaS and similar software, regardless of how it’s purchased or delivered and even if there’s nothing “tangible” about them. Beyond raising revenue, the California legislature likely had two reasons for this change:

• California is catching up with the many other states that already apply subject electronically delivered software, cloud offerings and other digital products to sales and use tax.
• The old boundary between “tangible” and intangible software just doesn’t work anymore given how technology and delivery methods have evolved. The CDTFA’s guidance tried (but often could not) draw clear lines.

SB 122 defines a “digital product” as prewritten computer software that’s delivered on physical media, transferred electronically, or accessed remotely. “Transferred electronically” means that the buyer can obtain, store, update or use the digital product without tangible media. But there as some important exceptions:

• The “digital products” definition excludes digital assets (e.g., NFTs or cryptocurrencies); audio, visual and audiovisual works (e.g., music and streaming services); books; and video games (even though other U.S. states may tax these items).
• The “digital products” definition also excludes “digital infrastructure” (e.g., cloud-based service provided remotely that lets you run your own computer software on someone else’s platform) under certain conditions.
• Other exemptions cover (a) purchases used solely outside California; (b) certain reproduction or resale rights; and (c) digital products that are really services driven primarily by human effort.
• Custom software and “golden masters” (e.g, sales of digital products where the buyer will resell the product to third parties) were already exempt before SB 122 and stay exempt.

SB 122 also spells out where a digital product sale is sourced (i.e., what location’s sale or use tax rate applies):

• Tangible storage media: Generally sourced to where the transfer occurs.
• In-person transactions (non-tangible delivery): Generally sourced to the seller’s place of business.
• Remote or electronic delivery: Generally sourced to the customer’s billing address.

If one cannot identify a California address then one can treat the sale as occurring outside the state, and tax does not apply.

Finally, if a single customer spends more than $5 million per year on digital products from a retailer, the collection obligation can shift from the retailer to the customer. In that case, the customer must self-assess, and remit use tax directly to the CDTFA.

Take aways

The new taxes take effect in 2027 but software vendors should start planning now. Updating customer contracts and tax compliance procedures is a long and involved process, so don’t put this off until January 2027.

• Keep up to date. The CDTFA still needs to issue rules over the coming months. Keep an eye on proposed regulations and news releases at https://cdtfa.ca.gov/news/.
• Pay attention to rates. Although California statewide sales/use tax rate is 7.25%, counties, municipalities, and special districts can pile on additional rates and bring the combined rate up to 10.25%. When you figure out where a sale is sourced, also check the local tax rate. The CDFTA has a handy rate- finder tool at https://maps.cdtfa.ca.gov/.
• Talk to your advisors. Get your tax and IT teams working now on which products count as taxable “digital products”; which might qualify for an exclusion or exemption; whether you need a seller’s permit from the CDTFA; and how to updating your billing and tax reporting and payment systems.
• Talk to your customers. Review your SaaS and software delivery contracts, and determine whether they let you charge for sales tax reimbursement. If not, think about amending now or updating at renewal. If they do, set up invoicing so the reimbursement shows as a separate line item. Either way, give your customers a head’s-up on new pricing, billing, and data collection procedures. They may not be happy, but they’ll appreciate the explanation.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.