California will tax many SaaS and software sales starting in 2027

ARTICLE | October 01, 2026

California is changing how it taxes software and software-as-a-service transactions.

Beginning January 1, 2027, California will generally apply sales and use tax to prewritten computer software whether it is delivered on physical media, downloaded electronically, or accessed remotely. That means SaaS arrangements you don't pay tax on today may become taxable in 2027.

This change matters whether you sell software or buy it for your business. It can also affect you if your company is located outside California but sells taxable software to California customers.

Sellers will usually collect the tax, but purchasers can be responsible too

In a typical taxable transaction, your software seller will collect the applicable California tax from you and remit it to the state. But that isn’t always the case.

You may have to report and pay California use tax directly when:

• An out-of-state seller does not collect California use tax.
• You claimed an exemption but later use the software in a taxable manner.
• The transaction falls under California's new direct-payment rules for certain large software purchases.

For example, assume your California business purchases a taxable SaaS subscription from an out-of-state vendor. If the vendor is not required to collect California tax and does not do so, your business may still owe California use tax on the purchase.

So don't assume that an invoice without sales tax means no tax is due.

An out-of-state software company may still have a California obligation

You don't need to be headquartered or physically located in California for these rules to matter.

For remote sales of electronically delivered or remotely accessed software, California generally looks to your customer's California address to determine where the transaction is treated as occurring. Whether you're required to register and collect California tax in the first place depends on separate rules about your California sales activity; SB 122 doesn't change that test, it just adds software to what counts toward it.

That distinction is important.

For example, a Texas-based software company could have California tax responsibilities if it sells enough taxable software or SaaS to customers located in California. Your headquarters location isn't the only factor.

Review both where your customers are located and whether your California sales create a registration and collection obligation.

SaaS is one of the biggest changes

SB 122 treats qualifying prewritten software as a taxable digital product whether the customer downloads it or accesses it remotely. That brings many of the SaaS arrangements you buy or sell into California's sales and use tax system.

Let's say your California business pays $100,000 each year to access a standard cloud-based accounting platform. Beginning in 2027, that subscription may be taxable even though you never receive or download a copy of the software.

If you sell software, review your product catalog before 2027. If you buy it, review your major SaaS contracts and determine whether vendors are expected to begin adding California tax to their invoices.

Not every digital product becomes taxable

The new law does not impose sales tax on every product or service delivered digitally.

Custom computer software generally remains exempt. The law also excludes several other categories outright, including digital infrastructure, digital books, audio and video works, and video games. Separately, California applies a "true object" test to distinguish taxable software from services: if what you're really buying is a person's work rather than a self-service product, that's generally treated as a service, not taxable software.

This distinction matters if you sell both technology and services.

For example, access to a standard software platform may be taxable, while a separately provided service that primarily consists of work performed by a professional may receive different treatment.

If you bundle software with implementation, consulting, or cloud services, review how those offerings are structured and billed.

Large purchasers may have to remit tax themselves

SB 122 includes an unusual rule for large transactions.

For 2027, once your aggregate purchases of electronically transferred or remotely accessed digital products from the same vendor exceed $5 million, responsibility for the tax may shift from your vendor to you.

If you're subject to this direct-payment requirement, you'll generally need to obtain a California Use Tax Direct Payment Permit, provide the appropriate certificate to your vendor, and report and pay the use tax directly to California.

The rules change somewhat beginning in 2028, and California is still developing procedures for direct payment and possible waivers.

Identify your major software vendors now. Spending several million dollars with one software provider could put you in a very different compliance process than purchasing smaller subscriptions from several vendors.

Businesses should start reviewing their exposure now

The rules don't take effect until January 1, 2027, but you can start preparing now.

If you sell software, review:

• Which products are likely to be taxable.
• Which customers are located in California.
• Whether your California sales require you to register and collect the tax.
• Whether your billing systems can calculate and collect the appropriate tax.
• Whether your contracts clearly address sales and use tax.

If you buy software, review:

• Your largest software and SaaS vendors.
• Whether California tax is currently being collected.
• Where your software users and business locations are.
• Whether any purchases may qualify for an exemption.
• Whether purchases from a single vendor could approach the direct-payment threshold.

A practical place to start is with your largest software contracts. Reviewing those arrangements first can help identify where your largest potential tax exposure sits.

Guidance is still developing

SB 122 is new, and it doesn’t take effect until January 1, 2027. The California Department of Tax and Fee Administration is developing regulations and additional guidance to interpret and implement the law.

That guidance may clarify how specific transactions, sourcing arrangements, exemptions, direct-payment procedures, and multistate software use will be handled.

Treat current guidance as a starting point and keep monitoring developments before the law takes effect.

If you are unsure whether the new rules apply to your software sales or purchases, or what steps your business should take before 2027, consider discussing your situation with a qualified tax or legal advisor.

This article is provided for general informational purposes only and does not constitute tax, accounting, or legal advice. The application of California sales and use tax rules depends on the facts and circumstances of each transaction. You should consult a qualified tax or legal advisor regarding how these rules may apply to your specific situation.