Software companies and their customers have operated for years under a simple assumption: cloud-based access isn’t a taxable sale in California. That assumption is now gone.
Under Senate Bill 122, signed as part of California’s 2026-27 budget package, the state has redefined “tangible personal property” to include prewritten computer software, regardless of how it’s delivered. Whether that software arrives on a disc, gets downloaded, or runs entirely in the cloud no longer matters for tax purposes. Beginning January 1, 2027, most of it is taxable.
For finance and tax leaders at software companies, and at any business that buys or resells SaaS products, this is a structural change, not a minor update. It affects pricing, invoicing, nexus exposure, and how contracts get sourced across state lines.
We work with companies navigating multistate tax complexity every day, and changes like this tend to catch even well-run finance teams off guard because the rules shift the underlying definitions, not just the rates.
What SB 122 Changes
Historically, California limited sales tax to items you could physically see or touch. Electronically delivered software and cloud access fell outside that definition. SB 122 removes that distinction.
The law now treats a “digital product” as taxable tangible personal property when it involves any transfer of the right to open, view, access, download, copy, update, possess, store, or manipulate prewritten software, whether that transfer happens on physical media, through a download, or via remote cloud access.
In practice, this language is broad enough to capture:
Enterprise SaaS platforms
Subscription-based software tools
Hosted applications accessed by client devices
What Stays Exempt
SB 122 does not tax everything digital. The law carves out several categories, including:
Custom software (as opposed to prewritten or “canned” software)
Digital books, audio works, audiovisual works, and visual works
Digital video game products
Digital infrastructure
There’s also a service-based exemption for digital products where the value comes primarily from human effort performed after the customer requests it, such as consulting or data processing. That exemption has a hard limit: it does not extend to a customer’s right to use a provider’s software running on cloud infrastructure, even when a web browser or client interface is the point of access. If your offering blends software access with a service layer, this distinction deserves a closer look before January 2027.
The $5 Million Threshold
Retailers get some relief from direct liability, but it’s tied to volume, not intent.
A retailer is relieved of the obligation to collect sales or use tax on digital product sales if its gross receipts from those sales to a purchaser exceed $5 million in the aggregate in the current calendar year (or, starting in 2028, in the current or preceding year). Past that threshold, the purchaser becomes responsible for self-assessing and remitting use tax directly to the California Department of Tax and Fee Administration.
This shifts the compliance burden rather than eliminating it. Large software vendors may not have to collect on every transaction once they cross the threshold, but their customers inherit the obligation instead. That’s a meaningful change to model into contract terms and internal use-tax accrual processes.
Sourcing Rules for Remote Software
Because digital products don’t have a physical location, SB 122 adopts a customer-based sourcing approach. Key points:
If the sale isn’t tied to tangible storage media and isn’t an in-person transaction, the sale is sourced to the purchaser’s known address on file with the seller.
The place of use is wherever the purchaser exercises the right to access the product.
A rebuttable presumption applies: if a digital product is purchased outside California and used in the state within 90 days of the sale, it’s presumed to have been purchased for use in California.
Retailers can be relieved of liability if they can show the CDTFA they made a reasonable, good-faith effort to obtain accurate purchaser address information. Address collection and documentation practices are worth reviewing now, before the rule takes effect.
Timeline
SB 122 was enacted as Chapter 23 of the Laws of 2026, effective June 29, 2026. The sales and use tax provisions apply starting January 1, 2027. Related income tax changes from the same legislation are addressed separately and are not part of this expansion.
Frequently Asked Questions
It taxes prewritten software accessed remotely, which covers most standard SaaS platforms. Custom-built software and certain digital content categories, like digital books or video games, remain exempt.
It depends on the vendor’s sales volume to purchasers. Vendors under the $5 million threshold generally collect and remit. Above that threshold, the purchaser is responsible for self-assessing and paying use tax directly to the CDTFA unless they receive a waiver from the CDTFA to be assessed sales tax by the retailer.
Custom software is excluded from the new definition, but the line between “custom” and “prewritten” isn’t always obvious, particularly for configurable platforms. This is worth reviewing product by product.
Possibly. The sourcing rules apply based on where the purchaser is located or where the product is used, not where the seller is headquartered. California’s economic nexus rules require retailers to register for sales and use tax if they source more than $500,000 of sales of tangible property to the state, which is now defined to include digital products. Companies with California-based customers should assess exposure regardless of their own location.
Start by mapping which products or services could be classified as taxable digital products under the new definition, then review contract language, invoicing systems, and address-verification processes to prepare for compliance.
Where This Leaves Finance Teams
SB 122 doesn’t just add a new tax line item. It changes how “sale” and “use” are defined for an entire category of products that many companies never expected to fall under sales tax rules. Getting ahead of the classification questions now, before the effective date, is far more manageable than untangling exposure after the fact.
If your company sells, resells, or purchases software that touches California customers, it’s worth reviewing your current setup against these new rules well before January 1, 2027.
