California has now enacted the software tax change that many technology companies were watching during the budget process. Governor Newsom signed the 2026-27 budget package on June 29, 2026, including Senate Bill (SB) 122, Taxation. Beginning January 1, 2027, California sales and use tax applies to certain digital products, including prewritten computer software that is transferred electronically or accessed remotely.
For software vendors, SaaS companies, and businesses that buy significant cloud software, the question is how each product, contract, customer location, invoice, and procurement process should be handled before the 2027 effective date.
California SB 122: What changed for Software and SaaS
The old rule is gone
California used to draw a line based on how software arrived. Under Regulation 1502, software delivered on a disc or downloaded was treated differently than software accessed remotely, with no physical media changing hands. That distinction made sense in 2005. It’s made less and less sense every year since, as companies moved to subscriptions, cloud platforms, and hosted tools.
SB 122 erases that line. Starting January 1, 2027, California treats a “digital product” — including prewritten software accessed remotely — as tangible personal property for sales and use tax purposes. That means Software-as-a-Service (SaaS).
The trigger language: SB 122 taxes software a customer accesses “for consideration” — by password, code, or similar means — where the software lives on the vendor’s server or a third party’s server. If your product fits that description, it’s now in scope, regardless of what you call it or how you price it.
Bottom line: Subscription software that was tax-free in California because nothing physical was ever delivered may now be taxable.
What’s still out of scope
SB 122 isn’t a blanket tax on everything digital. It carves out:
- Digital assets (including cryptocurrency)
- Digital audio and audiovisual works
- Digital books
- Digital infrastructure
- Digital video games
- Digital visual works
Custom software still isn’t taxed — but the bar is narrower than some companies assume. Software built to a single customer’s specifications stays exempt. A separately stated charge for modifying existing prewritten software can qualify too, but only for the modification itself, not the underlying product. And software doesn’t become “custom” just because it started life as an internal tool before you turned it into a product. If it’s now sold generally or repeatedly, it’s prewritten software in the state’s eyes — its origin story doesn’t matter.
Sourcing and purchaser records now become planning issues
SB 122 also creates sourcing rules for digital products that are transferred electronically or accessed remotely. For non-in-person transactions, the place of sale or purchase is generally based on the purchaser’s known address in the seller’s records, maintained in good faith in the ordinary course of business. If more than one address is available, the statute provides an order of priority, beginning with billing address.
That creates a documentation challenge for SaaS and software vendors with multi-location customers. Billing address may not always match user location, place of benefit, implementation location, or place of first use. Sellers should review whether their systems capture the information needed to support California sourcing and customer tax treatment. Purchasers should review whether vendor invoices reflect the correct California footprint, especially where users or business operations are spread across multiple states.
The California Department of Tax and Fee Administration has announced a workshop process to receive input on applying sales and use tax to digital products. The agenda includes sourcing rules, rules for determining place of use, and the shift from sales tax to purchaser-paid use tax when sales of digital products transferred electronically or accessed remotely to a purchaser exceed $5 million in a calendar year.
What businesses should do before 2027
January 1, 2027 sounds far off. It isn’t, for tax purposes. Companies that wait until year-end 2026 to sort out product classification, billing systems, and customer data may not have enough runway to be ready. Now is the time to figure out where your products land and where your exposure is.
Software vendors should begin with product mapping. Each revenue stream should be classified as prewritten software, custom software, implementation, support, data service, digital infrastructure, managed service, or a bundled offering. Contract language, invoice line items, exemption certificates, customer address data, and billing system settings should be tested before tax collection begins.
Purchasers should inventory recurring software spend now. Finance and tax teams should review SaaS, ERP, CRM, HR, accounting, cybersecurity, AI, cloud, and development platform contracts. Budget owners should expect some California software costs to increase in 2027, and tax teams should be ready to evaluate whether the seller is collecting correctly or whether use tax self-assessment may apply.
Companies with bundled offerings should be especially careful. A contract that combines software access, professional services, data processing, support, custom development, and infrastructure may need a more detailed taxability analysis than a standard subscription. The best support is often built before the contract is signed and before the invoice is issued.
How Aura Advisors can help with California SaaS tax
California’s enacted SaaS tax affects more than software vendors. It can change pricing, procurement, contract drafting, invoicing, sourcing, use tax controls, and audit documentation. The businesses most likely to feel pressure are those with recurring software revenue, multi-state customers, high software spend, bundled digital offerings, or California credit and cash-flow planning already underway.
Aura Advisors helps businesses review California SaaS tax exposure with a practical and defensible approach. We can help classify software and service revenue, review contracts and invoice presentation, evaluate sourcing records, coordinate sales and use tax processes, and model related California tax planning issues based on the company’s facts. General guidance can identify the issue, but the right compliance posture depends on each product, customer base, system, and documentation trail.
For More Reading:
- No Profit But Still Taxed? How Gross Receipts Trigger State Exposure
- California Corporate Suspension Can Bar Tax Court Review
- California Court Limits State Tax Reach Over Out-of-State Sole Proprietors
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.