California Will Tax SaaS Starting 2027: What SB 122 Means for Sellers and Buyers

California has been one of the more favorable states for software transactions when it comes to sales tax. Prewritten software delivered on tangible media has long been taxable, but software delivered electronically or accessed remotely, including software as a service, has generally fallen outside the sales and use tax base. That era is coming to an end. On June 29, 2026, Governor Newsom signed Senate Bill 122 into law as part of the state’s 2026-27 budget, and effective January 1, 2027, California sales and use tax will apply to prewritten computer software regardless of how it is delivered.

What SB 122 Actually Taxes: Prewritten Software, However It’s Delivered

The new law expands the definition of tangible personal property to include a digital product, which is defined to mean prewritten computer software transferred on tangible storage media, transferred electronically, or accessed remotely. In practical terms, this means SaaS subscriptions, downloaded software, and cloud-based software access will all be subject to sales tax. The state estimates the change will generate two billion dollars annually in combined state and local revenue, which gives a sense of just how broad the impact will be.

What’s Still Exempt: Custom Software and Other Digital Products

There are important boundaries to the new tax. Custom software, meaning software prepared to the special order of a single customer, remains exempt, and modifications to prewritten software can qualify as custom to the extent of the modification if the charges are separately stated. The law also does not expand the tax base to transactions involving other products of a digital nature, so items like digital books, music, streamed media, video games, digital infrastructure, and digital assets such as cryptocurrency remain non-taxable.

The $5 Million Threshold: When the Tax Liability Shifts to the Buyer

One feature that deserves particular attention is a liability shift for large software relationships. Where a retailer’s gross receipts from sales of digital products to a purchaser exceed five million dollars in a calendar year, the obligation moves from the seller to the buyer, who must self-assess and remit use tax directly to the California Department of Tax and Fee Administration (CDTFA). This means the compliance burden of SB 122 will not fall on software vendors alone. Companies that purchase significant amounts of software for use in California will need processes in place to track spending, self-assess where required, and document any exemptions.

Sourcing Rules and the Multistate License Problem

The law also leaves some open questions. Unlike states such as New York and Texas, California did not include a statutory mechanism allowing purchasers to allocate a subscription price based on where users are located, which creates uncertainty for multistate licenses and enterprise agreements pending further guidance from the CDTFA.

Except for in-person transactions, destination sourcing for local and district taxes will apply to sales of a taxable digital product through a hierarchy of known addresses. While sourcing rules from SB 122 will have similarities with those of other states, they do deviate from the sourcing rules established by the Streamlined Sales and Use Tax Agreement (SSUTA).

How Sellers Should Prepare for the January 1, 2027 Deadline

For sellers, the immediate priorities are clear. Companies should evaluate whether their offerings constitute taxable prewritten software or exempt custom software or services, confirm whether they have nexus with California, register where required, and make sure billing systems and tax engines can calculate the correct state, local, and district rates by customer address. Contracts should be reviewed for tax pass-through language, and exemption certificate procedures should be in place before the effective date.

How Buyers Should Prepare for the January 1, 2027 Deadline

For buyers, the focus should be on budgeting for the added cost, reviewing large software agreements against the five-million-dollar threshold, and preparing for self-assessment obligations where they apply. January 1, 2027, may sound distant, but system changes, registrations, and contract updates routinely take months to complete, and businesses that wait for final CDTFA guidance may find themselves short on time.

KBF Advisory, LLC constantly monitors changes like these in state sales and use tax laws so our clients are never caught off guard. If your business sells or purchases software or SaaS and you are facing questions about how this upcoming change affects your California obligations, our state and local tax team is here to assist. Please reach out to Troy Bluske at tbluske@kbfadvisory.com or Tracey Stewart at tstewart@kbfadvisory.com to discuss how SB 122 may impact your business and how to prepare before the January 1, 2027, effective date.