For decades, software sold over the internet lived in a gray area of sales tax law. States wrote their tax codes when “tangible personal property” meant something you could hold in your hands. Software didn’t fit neatly into that world, so most states either exempted it, taxed it inconsistently, or just looked the other way.
California just changed the rules.
Senate Bill 122, passed by the California Legislature on June 18, 2026, and now awaiting Governor Newsom’s signature, would redefine “tangible personal property” to include digital products, specifically prewritten computer software. That includes software you download. Software you access through a browser. SaaS platforms your team logs into every day. If signed, those purchases would be subject to California sales and use tax starting January 1, 2027.
The bill has broad support across the legislature and is described as part of a three-party consensus agreement among the Assembly, Senate, and Governor. Signature is widely expected. But until it happens, this remains a proposal, not a mandate.
That said: the January 2027 effective date leaves almost no runway. If you wait for the governor’s signature before you start preparing, you will already be behind. Here’s what the bill does and what you should be doing now.
What Changed, Exactly
California’s Sales and Use Tax Law has always taxed “tangible personal property,” meaning things you can see, touch, weigh, or measure. SB 122 would add a second category to that definition: digital products and any copyright or patent interests associated with them.
A “digital product” under the new law means prewritten computer software. That covers three delivery methods:
- Transferred on tangible storage media: software on a disc or USB drive (already taxable in most cases, now codified)
- Transferred electronically: software you download directly
- Accessed remotely: software that runs on the vendor’s server and you access via password or digital code (what most people call SaaS or cloud software)
The law is specific that this applies to prewritten software, meaning software that exists for general or repeated sale. Custom software built specifically for your company is still excluded.
What’s Not Included
The bill carves out several categories from the “digital product” definition. These would be exempt from the new tax:
- Digital audio works: music, podcasts, ringtones
- Digital audiovisual works: streaming video, films
- Digital books: ebooks and the like
- Digital video games: consumer gaming products
- Digital visual works: digital artwork
- Digital assets: cryptocurrency and similar blockchain-based instruments
- Digital infrastructure: cloud services where you run your own software on someone else’s platform
That last carve-out deserves attention. “Digital infrastructure” means cloud-based services where the customer creates, deploys, scales, or runs their own software on the provider’s platform, without managing the underlying hardware or network. Think AWS, Google Cloud, Microsoft Azure. Those are explicitly excluded.
The line being drawn here is between using someone else’s software (taxable) and running your own software on someone else’s infrastructure (not taxable). If your business relies heavily on IaaS or PaaS providers, those costs are outside the scope of this law. If your team logs into a vendor’s SaaS platform to do work, those subscriptions are now in scope.
The $5 Million Threshold: A Major Compliance Wrinkle for Enterprise Buyers
Here’s where it gets operationally complicated for mid-market and larger companies.
The bill includes a threshold provision: if a purchaser buys more than $5 million in taxable digital products from a single retailer in a calendar year, the retailer would be relieved of the obligation to collect and remit the tax. The purchaser would become responsible for self-assessing and paying use tax directly to the California Department of Tax and Fee Administration (CDTFA).
That $5 million figure is per retailer, per year. It is not a combined total across all your software vendors. It is vendor-by-vendor. And starting January 1, 2028, it applies if you exceeded the threshold in either the current or the preceding calendar year.
If this threshold applies to you, you will need to obtain a use tax direct payment permit from the CDTFA. That permit requires you to register the California business locations where you expect to first use the software, and to file and pay use tax returns directly. This is not a passive process. It creates active compliance obligations that many finance teams are not currently set up to handle.
For most mid-market companies, the $5 million threshold won’t apply to any single software vendor. But if you have large enterprise agreements covering a major ERP platform, a sprawling CRM, or a mission-critical cloud suite, it’s worth doing the math now, before 2027 arrives.
Sourcing Rules: Where Does the Sale Happen?
SB 122 would establish clear rules for determining where a digital product sale is sourced, which matters for figuring out what local sales tax rate applies.
For software that isn’t sold in person at a physical location, the sourcing hierarchy works like this:
- Purchaser’s billing address
- Purchaser’s shipping or delivery address
- Mailing address associated with the purchaser’s payment instrument
- Purchaser’s mailing address
The bill also includes a presumption worth knowing: if you purchase a digital product from outside California and use it in California within 90 days of purchase, it’s presumed the purchase was made for use in California. Use tax applies, regardless of where the transaction technically occurred.
This is the state closing a gap. Companies that historically purchased software from out-of-state vendors and didn’t pay California sales tax will now have a clear, codified obligation to self-report and pay use tax on those purchases.
What This Means If You Sell Software
If SB 122 is signed and your company sells prewritten software to California customers, whether via download or SaaS subscription, you would have new collection obligations starting January 1, 2027.
If your California customer buys less than $5 million from you annually, you collect and remit just like you would for any other taxable product. The sourcing rules are clear, and the CDTFA is receiving $750,000 in funding specifically to build out the administrative infrastructure for this.
The more complex situation involves multi-state licensing. If you sell a software license that covers users in multiple states simultaneously, California’s law allows for an apportionment methodology. The CDTFA is authorized to set rules for how to calculate the tax due on licenses with concurrent multi-location use. Those rules don’t exist yet. They need to be developed before 2027. If you have licenses spanning multiple jurisdictions, watch for CDTFA guidance closely.
There’s also a good-faith protection built in. If a retailer uses a customer’s address information in good faith and that information turns out to be inaccurate, the retailer isn’t liable for the resulting error. But good faith means you actually tried. Documenting your sourcing methodology will matter if you’re ever audited.
The Anti-Rebate Provision
One additional piece worth flagging: SB 122 would prohibit any purchaser or retailer of digital products from entering into an agreement that would redirect, rebate, or divert Bradley-Burns local sales tax revenue from a digital product sale. Local agencies would face the same prohibition.
This closes a loophole some jurisdictions had used to attract retail operations, essentially agreeing to kick back local sales tax revenue to retailers as an economic incentive. That practice is now off the table for digital product transactions, full stop.
What You Should Be Doing Right Now
January 2027 feels distant. It isn’t. Here’s how to use the time you have.
Audit your software spend. Pull a complete list of your SaaS and software subscriptions. Categorize them: Is this prewritten software? Is it delivered electronically or accessed remotely? What’s the annual spend with each vendor? How many of your users or business locations are in California? This inventory is the foundation of everything else.
Check against the exclusions. Work through the carve-outs. Infrastructure-as-a-service, gaming products, digital media, digital books: if any of your software spend falls into those categories, document the basis for the exclusion. The burden of proof lives with the purchaser.
Identify your $5 million vendors. If you have any single software vendor where your California purchases could approach $5 million annually, flag that relationship now. Getting a use tax direct payment permit set up and filing a return directly with the CDTFA is a very different process than receiving a tax line on a vendor invoice. Your team needs time to build that workflow.
Talk to your vendors. Your software vendors are working through this too. They will need to update their billing systems, invoicing, and exemption certificate processes. Start the conversation early. Ask how they’re planning to handle California tax collection starting in 2027. If they don’t have an answer yet, that’s a signal to follow up.
Review your exemption certificate situation. If you currently hold resale certificates or other exemption documentation with software vendors, make sure those are current. You’ll want your records clean before the new rules take effect.
Get ahead of use tax exposure. If your company has been buying out-of-state software and not self-assessing California use tax, the new law makes that obligation explicit and enforceable. A voluntary disclosure approach, handled before an audit notice arrives, is almost always a better outcome than one that isn’t.
The Bottom Line
California’s SB 122 is not yet law. But it passed with broad legislative support as part of a consensus budget agreement, the governor is expected to sign it, and the January 1, 2027 effective date is fixed in the bill text. The gap between “expected to be signed” and “signed” is not a reason to wait.
The companies that will struggle are the ones treating this as something to revisit after the governor acts. The companies that won’t are the ones mapping their exposure now, having the right conversations with vendors and advisors, and building the internal processes to handle a new category of taxable spend before the deadline hits.
We are monitoring SB 122 closely and will update this article when the governor signs. If you want to understand your California digital products exposure before that happens, we’re happy to take a look.
That last carve-out deserves attention. “Digital infrastructure” means cloud-based services where the customer creates, deploys, scales, or runs their own software on the provider’s platform, without managing the underlying hardware or network. Think AWS, Google Cloud, Microsoft Azure. Those are explicitly excluded.
The line being drawn here is between using someone else’s software (taxable) and running your own software on someone else’s infrastructure (not taxable). If your business relies heavily on IaaS or PaaS providers, those costs are outside the scope of this law. If your team logs into a vendor’s SaaS platform to do work, those subscriptions are now in scope.
The $5 Million Threshold: A Major Compliance Wrinkle for Enterprise Buyers
Here’s where it gets operationally complicated for mid-market and larger companies.
The law includes a threshold provision: if a purchaser buys more than $5 million in taxable digital products from a single retailer in a calendar year, the retailer is relieved of the obligation to collect and remit the tax. The purchaser becomes responsible for self-assessing and paying use tax directly to the California Department of Tax and Fee Administration (CDTFA).
That $5 million figure is per retailer, per year. It is not a combined total across all your software vendors. It is vendor-by-vendor. And starting January 1, 2028, it applies if you exceeded the threshold in either the current or the preceding calendar year.
If this threshold applies to you, you will need to obtain a use tax direct payment permit from the CDTFA. That permit requires you to register the California business locations where you expect to first use the software, and to file and pay use tax returns directly. This is not a passive process. It creates active compliance obligations that many finance teams are not currently set up to handle.
For most mid-market companies, the $5 million threshold won’t apply to any single software vendor. But if you have large enterprise agreements covering a major ERP platform, a sprawling CRM, or a mission-critical cloud suite, it’s worth doing the math now, before 2027 arrives.
Sourcing Rules: Where Does the Sale Happen?
California’s new law establishes clear rules for determining where a digital product sale is sourced, which matters for figuring out what local sales tax rate applies.
For software that isn’t sold in person at a physical location, the sourcing hierarchy works like this:
- Purchaser’s billing address
- Purchaser’s shipping or delivery address
- Mailing address associated with the purchaser’s payment instrument
- Purchaser’s mailing address
The bill also includes a presumption worth knowing: if you purchase a digital product from outside California and use it in California within 90 days of purchase, it’s presumed the purchase was made for use in California. Use tax applies, regardless of where the transaction technically occurred.
This is the state closing a gap. Companies that historically purchased software from out-of-state vendors and didn’t pay California sales tax will now have a clear, codified obligation to self-report and pay use tax on those purchases.
What This Means If You Sell Software
If your company sells prewritten software to California customers, whether via download or SaaS subscription, you have new collection obligations starting January 1, 2027.
If your California customer buys less than $5 million from you annually, you collect and remit just like you would for any other taxable product. The sourcing rules are clear, and the CDTFA is receiving $750,000 in funding specifically to build out the administrative infrastructure for this.
The more complex situation involves multi-state licensing. If you sell a software license that covers users in multiple states simultaneously, California’s law allows for an apportionment methodology. The CDTFA is authorized to set rules for how to calculate the tax due on licenses with concurrent multi-location use. Those rules don’t exist yet. They need to be developed before 2027. If you have licenses spanning multiple jurisdictions, watch for CDTFA guidance closely.
There’s also a good-faith protection built in. If a retailer uses a customer’s address information in good faith and that information turns out to be inaccurate, the retailer isn’t liable for the resulting error. But good faith means you actually tried. Documenting your sourcing methodology will matter if you’re ever audited.
The Anti-Rebate Provision
One additional piece worth flagging: the law prohibits any purchaser or retailer of digital products from entering into an agreement that would redirect, rebate, or divert Bradley-Burns local sales tax revenue from a digital product sale. Local agencies face the same prohibition.
This closes a loophole some jurisdictions had used to attract retail operations, essentially agreeing to kick back local sales tax revenue to retailers as an economic incentive. That practice is now off the table for digital product transactions, full stop.
What You Should Be Doing Right Now
January 2027 feels distant. It isn’t. Here’s how to use the time you have.
Audit your software spend. Pull a complete list of your SaaS and software subscriptions. Categorize them: Is this prewritten software? Is it delivered electronically or accessed remotely? What’s the annual spend with each vendor? How many of your users or business locations are in California? This inventory is the foundation of everything else.
Check against the exclusions. Work through the carve-outs. Infrastructure-as-a-service, gaming products, digital media, digital books: if any of your software spend falls into those categories, document the basis for the exclusion. The burden of proof lives with the purchaser.
Identify your $5 million vendors. If you have any single software vendor where your California purchases could approach $5 million annually, flag that relationship now. Getting a use tax direct payment permit set up and filing a return directly with the CDTFA is a very different process than receiving a tax line on a vendor invoice. Your team needs time to build that workflow.
Talk to your vendors. Your software vendors are working through this too. They will need to update their billing systems, invoicing, and exemption certificate processes. Start the conversation early. Ask how they’re planning to handle California tax collection starting in 2027. If they don’t have an answer yet, that’s a signal to follow up.
Review your exemption certificate situation. If you currently hold resale certificates or other exemption documentation with software vendors, make sure those are current. You’ll want your records clean before the new rules take effect.
Get ahead of use tax exposure. If your company has been buying out-of-state software and not self-assessing California use tax, the new law makes that obligation explicit and enforceable. A voluntary disclosure approach, handled before an audit notice arrives, is almost always a better outcome than one that isn’t.
The Bottom Line
California has been one of the last major states to bring software purchases clearly into its sales tax framework. The 2027 effective date gives businesses time to prepare, but that time is finite, and the compliance infrastructure you need to build doesn’t happen overnight.
The companies that will struggle are the ones that treat this as a 2026 problem. The companies that won’t are the ones mapping their exposure now, having the right conversations with vendors and advisors, and building the internal processes to handle a new category of taxable spend before the deadline hits.
If you’re not sure where your company stands on California digital products exposure, that uncertainty is itself the answer. This is a good time to get clarity.
The post California Is Coming for Your Software: What the 2027 Digital Products Tax Means for Your Business appeared first on The Sales Tax People.