Governor Newsom has signed California’s 2026-27 budget, including Senate Bill (SB) 122, Taxation. For technology companies and California businesses, the headline is the new tax treatment for Software-as-a-Service (SaaS) and digital prewritten software. But the broader planning issue reaches further: California also extended its business credit limitation, created a post-2030 credit cap framework, and temporarily reduced the first-year annual tax for certain new entities.
Businesses should not treat this as a single sales tax update. The budget affects product pricing, purchasing, R&D credit usage, cash-flow modeling, and entity formation decisions.
SaaS and digital prewritten software become taxable in 2027
Beginning January 1, 2027, California expands the definition of tangible personal property to include certain “digital products.” Under SB 122, digital products generally mean prewritten computer software transferred on tangible storage media, transferred electronically, or accessed remotely. That means SaaS and other remotely accessed prewritten software may now fall within California sales and use tax.
A terminology point deserves care. SB 122 does not sweep cryptocurrency or similar digital assets into this sales tax base. The statute specifically excludes a “digital asset” from the digital product definition. For most businesses, the practical question is not whether California now taxes crypto. It is whether the company sells, licenses, purchases, or provides access to taxable prewritten software.
Custom software remains a key boundary. Businesses selling implementation, configuration, support, data access, managed services, AI-enabled tools, or bundled offerings should review how contracts and invoices describe each component. Product classification, customer location, place of use, exemption documentation, and billing system readiness should be addressed before the 2027 effective date.
For a deeper dive into the changes impacting California sales tax on digital products, including SaaS: see our insight here
Business Credit Limitations
California already limited the use of business credits to $5 million for taxable years beginning of or after January 1, 2024 and before January 1, 2027. SB 122 extends that $5 million limitation through taxable years beginning before January 1, 2030. Credits disallowed because of the limitation generally remain carryovers, and the carryover period is extended by the number of years the credit was not allowed.
For taxable years beginning on or after January 1, 2030, SB 122 creates a continuing limitation framework. Business credits generally may not reduce tax by more than 70% or $5 million, whichever is greater, subject to statutory exceptions.
For startups, technology companies, life sciences companies, and other businesses investing heavily in research, this calls for multi-year modeling. A company may generate a valuable California R&D credit and still be unable to use the full amount in the year expected. That affects estimated taxes, provision modeling, valuation conversations, and decisions about where and when to make additional investments.
The refundable credit election rules also continue through taxable years beginning before 2030. That election may help some taxpayers convert limited credits into a refundable stream over time, but it is irrevocable and must be made on an original, timely filed return. It should be modeled before the return is filed, not revisited after the filing posture is locked.
First-year entity tax relief is helpful, but should not drive entity choice
SB 122 temporarily reduces the first-year annual tax for certain California entities. For taxable years beginning on or after January 1, 2027, and before January 1, 2030, the first-year annual tax for LLCs, LPs, and LLPs is reduced from $800 to $400.
For founders forming a California LLC, LP, or LLP during that window, the savings are real, but modest. Entity choice should still be based on liability structure, investor expectations, financing plans, ownership economics, self-employment tax, pass-through treatment, exit strategy, state filing obligations, and administrative complexity.
A $400 first-year savings should not outweigh a more durable tax or legal structure. For some founders, an LLC will still make sense. For others, a corporation, partnership, or out-of-state formation with California qualification may be more appropriate.
What businesses should do now
Companies should move from awareness to modeling. SaaS sellers should map revenue streams, contract language, customer location data, invoicing fields, and exemption certificate processes. SaaS purchasers should inventory major software contracts and identify whether vendors may begin charging California tax in 2027.
Businesses with California credits should update multi-year projections to show how much credit can actually be used under the extended cap. R&D-heavy companies should reconcile federal and California credit workpapers, confirm carryforward schedules, and evaluate whether any refundable credit election is worth considering.
Founders planning new entities in 2027 through 2029 should factor in the first-year tax reduction, but only after selecting the right entity structure for the business.
How Aura Advisors can help with California budget tax changes
California’s budget changes create overlapping planning pressures. A company may face new sales or use tax on software, delayed credit utilization, and entity formation decisions in the same planning cycle. General guidance can identify the issues, but the right filing and planning posture depends on the company’s products, customers, contracts, credits, ownership structure, and California footprint.
Aura Advisors helps businesses evaluate California budget tax changes with a practical, defensible approach. We can help classify software and service revenue, model California credit usage, assess R&D credit timing, review entity formation options, and coordinate documentation before tax positions become filing positions.
For More Reading:
- Will California Enacts SaaS Tax
- Maximizing the California PTE Tax Election: Updated Rules Through 2030
- The Interplay Between IRC Sections 174 and 41
Aura Advisors is a boutique tax consulting and compliance firm working with start-ups, emerging growth companies, and affluent individuals. Making it safer for good people and good companies to continue to do good things.