Article
California SB 122 expands sales tax to software and digital products beginning 2027
July 9, 2026 · Authored by James Levinson, Anna Ferraro and Ryan Galinaitis
California Governor Gavin Newsom signed SB 122 (the legislation) on June 29, 2026, which expands the sales and use tax base to include electronically delivered software, Software as a Service (SaaS), and certain digital products, known as taxable software and digital products.
The legislation redefines these items as tangible personal property for sales and use tax purposes and as a result, the sales and use tax will apply to prewritten software delivered electronically, remotely accessed SaaS, and digital products, unless specifically excluded.
The legislation goes into effect beginning Jan. 1, 2027.
What’s excluded?
The following types of digital transactions continue to be exempt:
- Infrastructure. The use of a cloud-based service that allows a user to remotely create, deploy, scale, or run the user’s own software on a third-party provider’s digital platform.
- Assets. A digital representation of value, such as cryptocurrency, that’s recorded on a cryptographically secured distributed ledger or similar technology.
- Audio work. Created audio works such as podcasts and music streaming services.
- Audiovisual work. Creative works that contain both audio and visual elements. Examples of this include streaming videos, online courses, and video podcasts.
- Books. Books transferred electronically or accessed remotely.
- Products or services that primarily involve the application of human effort. Services where software is used in providing a service, but the service primarily involves human effort and the human effort is originated after being engaged by the customer.
Taxability, sourcing, and compliance considerations for SB 122
Accordingly, business software purchases that are electronically downloaded or remotely accessed will be subject to sales and use tax while products such as digital music, movie streaming apps, and digital books continue to be exempt.
For sourcing purposes, the sale or purchase of taxable software and digital products is determined by a hierarchy of addresses or information provided by the customer. It remains unclear whether California customers will be able to source the cost of the taxable software and digital products to users located in multiple states, particularly for enterprise licenses.
For taxable software and digital products valued over $5,000,000, the responsibility of reporting and paying the tax is shifted from the software retailer to the purchaser with requirements to allocate the California use tax to the various local jurisdictions where the taxable software and digital products are used. The legislation prohibits local jurisdictions from entering into local tax sharing agreements on sales of taxable software and digital products.
Exemptions for custom software and sales for resale, including production licenses, remain; however, exemptions such as the partial exemption for manufacturing, R&D, and energy production and storage may not apply to taxable software and digital products.
How can my business prepare for compliance with SB 122?
Businesses not currently registered for sales and use tax in California may now need to register for sales and use tax as either a seller or consumer of taxable software and digital products.
Because the legislation enacts such a significant sales and use tax change, software companies should proactively assess its impact and determine the next steps to become sales tax compliant. Specifically, required nexus studies, product taxability reviews, registrations, tax engine implementation, exemption certificate procedures, contract updates, and internal training often require months to complete.
Businesses that delay evaluating the impact of the legislation may find themselves with insufficient time to implement the systems and processes needed to comply by Jan. 1, 2027.
Accordingly, businesses should consider consulting with their state and local tax advisors to understand the potential impact on their business, including:
- Evaluate which products qualify as taxable digital products, and which may fall under statutory exclusions or exemptions.
- Understand what changes will be required to billing platforms and tax engines to calculate the appropriate state, local, and district sales taxes as a result of the legislation.
- Revise financial budgets to reflect the increased cost of previously exempt software.
What’s next?
The California Department of Tax and Fee Administration has announced upcoming meetings to discuss new regulations to address this expansion of the sales and use tax.
While California develops new regulations to provide additional guidance for taxpayers, software sellers should use the next five months to coordinate with their state and local tax teams to evaluate their sales tax footprint, the potential impact of the legislation, and establish a scalable compliance process.
Buyers of software should look at where their software is used to ensure the correct amount of sales and use tax is paid to California or other states where users are located.
