California to tax software and SaaS in 2027

The enactment of Senate Bill 122 extends California sales and use tax to digital products starting January 1, 2027. The bill defines “digital product” as “prewritten computer software transferred on tangible storage media, transferred electronically, or accessed remotely,” and tasks the California Department of Tax and Fee Administration (CDTFA) with establishing guidance for taxpayers.

CDTFA is on it. It held a Digital Products Workshop on July 21, 2026, to discuss and receive input on the application of sales and use tax to digital products. It used what it learned to create a discussion paper on the topic, which it published on September 1, 2026. And it hosted another discussion for interested parties on September 10, 2026. Read on for details. 

Key takeaways

• California will tax SaaS and prewritten software. Software as a Service (SaaS) and prewritten software will be subject to California sales and use tax starting January 1, 2027.
• Most other digital goods and services will remain exempt. SB 122 explicitly excludes many other digital products from sales and use tax, including digital assets (e.g., cryptocurrency), digital audio/visual works, digital books, digital infrastructure, digital video games, and streamed media.
• CDTFA is drafting emergency regulations to facilitate compliance. To clarify requirements for taxpayers, CDTFA is hosting discussions and drafting emergency regulations related to the application of sales and use tax to digital products. 

What California SB 122 taxes

SB 122 extends California sales and use tax to prewritten computer software and SaaS effective January 1, 2027. Other digital goods, such as ebooks, music, and streamed content, remain exempt from California sales and use tax under the bill.

California Revenue and Taxation Code currently defines “tangible personal property” as “personal property which may be seen, weighed, measured, felt, or touched, or which is in any other manner perceptible to the senses.”

SB 122 amends the definition of tangible personal property to mean either:

1. Personal property that can be seen, weighed, measured, felt, touched, or is in any other manner perceptible to the senses; or
2. A digital product and any copyright or patent interests associated therewith.

In many states, “digital product” includes digital audio products, digital books, and the like. That’s not the case in California. SB 122 defines digital product as “prewritten computer software transferred on tangible storage media, transferred electronically, or accessed remotely.” This means “computer software that is held or existing for general or repeated sale or lease, even if the prewritten software was initially developed on a custom basis for in-house use, including the combination of two or more prewritten programs.”

Fully custom software would remain exempt.

SB 122 also specifically excludes the following from the definition of digital product — and therefore from taxation.

• A digital asset, defined as “a digital representation of value that is recorded on a cryptographically secured distributed ledger or any similar technology”
• A digital audio work, digital audiovisual work, or digital visual work
• A digital book
• Digital infrastructure, defined as “a cloud-based service provided remotely that allows a user to create, deploy, scale, or run the user’s own computer software on the service provider’s digital platform without managing, operating, or maintaining the user’s own infrastructure, including any hardware, software, networks, and facilities that are required to allow the user to create, deploy, scale, or run the user’s own computer software, required to complete the task”
• A digital video game product

Additionally, the bill states that for the purposes of use tax liability, “‘storage’ and ‘use’ do not include the keeping, retaining, or exercising of any right or power over a digital product for the purpose of installing or deploying the digital product for use thereafter solely outside the state.”

How will California source sales of software and SaaS?

Properly sourcing sales of digital products and services is essential for sales and use tax compliance, and SB 122 provides clear sourcing rules.

The place of sale or purchase of a digital product transferred on tangible storage media is the place where the tangible storage media is physically located at the time of sale.

For a digital product not transferred on tangible storage media, the following sourcing rules apply:

1. If the transaction takes place in person or at the location of a seller with a seller’s permit, the sale is sourced to the seller’s place of business in California where the in-person sale or purchase occurred.
2. If the transaction was not in person or at the location of the seller, the sale is sourced to the purchaser’s known address in California as shown by the seller’s records.
3. If the purchaser provided more than one address, use the following order of priority:
   • The purchaser’s billing address
   • The purchaser’s shipping or delivery address
   • The mailing address associated with the purchaser’s payment instrument
   • The purchaser’s most recent mailing address
4. If the purchaser didn’t provide an address, use addresses previously provided by the purchaser to the seller in the following order of priority:
   • The purchaser’s most recent billing address
   • The purchaser’s most recent shipping or delivery address
   • The purchaser’s most recent mailing address associated with the purchaser’s payment instrument
   • The purchaser’s most recent mailing address

If none of the above apply, the sale of a digital product transferred electronically or accessed remotely “shall be deemed to be outside of this state.”

These are similar to the sourcing rules recommended by the Streamlined Sales Tax Governing Board and many states. However, prioritizing the billing address when a buyer provides more than one address is unusual, and during the September 10 discussion, several interested parties voiced concerns about this provision. 

Read this state-by-state guide to the taxability of digital products for more on the sourcing of digital transactions.

Liability for sales and use tax

SB 122 shifts liability from the retailer to the purchaser if the gross receipts from the sale of digital products exceed $5 million per year in 2027, or $5 million in the current or preceding calendar year starting January 1, 2028. For such transactions, instead of the retailer collecting and remitting sales tax, the purchaser must self-assess and remit use tax.

The bill doesn’t provide a method for businesses to allocate tax to account for software or SaaS used outside of California. However, CDTFA “may set forth, authorize, or require alternative methods to calculate the sales or use tax due in this state that fairly reflects the sales or use tax due on any digital product sold or purchased for use in this state, including on licenses of digital products concurrently available for use in multiple locations.”

Multiple points of use is one of several topics addressed in CDTFA’s draft regulations.

CDTFA draft regulations 

To cleanly implement the sales and use tax changes established by SB 122, CDTFA will need to update or amend certain existing guidance and regulations. That process started before July 21, 2026, when CDTFA hosted a Digital Products Workshop to help prioritize topics for rulemaking.

Taxpayers and interested parties identified issues related to exclusions from the definition of digital products, the exemptions specified in SB 122, multiple points of use for digital products, the timing and place of sale for digital products, and use tax direct payment permits.

CDTFA took those ideas into consideration and published a discussion paper on September 1, 2026. It proposes the following actions.

• Amend Regulation 1502, Computers, Programs, and Data Processing
• Establish a new Regulation 1502.2.
• Amend Regulation 1507, Technology Transfer Agreements (TTAs) 
• Establish Regulation 1600, Application of Sales and Use Tax to Digital Products
• Establish Regulation 1601, Tax Liability Threshold for Digital Products
• Establish Regulation 1600.2, Digital Products Purchased for Multiple Points of Use
• Establish Regulation 1600.3, Digital Products Purchased Solely for Use Outside this State or in Interstate or Foreign Commerce
• Amend Regulation 1699.6, Use Tax Direct Payment Permits

See the CDTFA discussion paper for the details.

There’s more work to be done, but this is a solid starting point. Interested parties discussed these proposals with the CDTFA on September 10, 2026, identifying potential compliance issues for taxpayers. The CDTFA will consider their feedback as they finalize the emergency regulations.

Bottom line

California is one of a growing number of states looking to expand their sales tax base. Amanda Denniston, Government Relations Manager at Avalara, says California’s shift is a direct response to two converging realities: an urgent need for revenue to address significant budget deficits, and a tax code that was becoming increasingly difficult to justify. “States need to modernize their rules as our economy has transitioned almost entirely to digital and cloud-based consumption in software products.”

January 2027 will be here before you know it. If your business buys or sells software or SaaS, consider how California SB 122 will impact your California sales and use tax obligations, and what you’ll need to do to prepare.

Avalara helps businesses comply with changing tax requirements in California and other states. This can be particularly beneficial to businesses that sell software and SaaS, as the taxability of digital products varies from state to state.

“It’s great that Avalara understands those nuances,” says a tax analyst at Duo, which provides user-centric two-factor authentication, endpoint remediation, and secure single sign-on tools. “Avalara’s reports are designed to satisfy an auditor’s expectations. So when or if an audit comes, Avalara gives us much greater confidence in the outcome.”

There are other benefits as well. By streamlining the tax calculation and filing processes, Avalara has liberated Duo’s tax team to focus on higher-value activities. In fact, by automating sales tax calculation with Avalara AvaTax, Duo estimates they’ve saved roughly a half million dollars.

Learn more about Avalara AI-powered tax compliance solutions purpose-built for software and digital goods.

FAQ

Will California tax Software as a Service (SaaS)?

Yes. Governor Newsom signed Senate Bill 122 into law on June 29, 2026, so California will apply sales and use tax to Software as a Service (SaaS) and prewritten computer software starting January 1, 2027.

Are digital goods like ebooks and streamed music taxable in California?

No. California SB 122 specifically exempts many digital goods from sales and use tax. This means digital books, digital audio and visual works (like streamed movies or music), digital video games, and digital assets remain nontaxable.

Will California tax IaaS or PaaS in 2027?

Under Proposed Regulation 1600, “cloud-based Infrastructure as a Service (IaaS) and Platform as a Service (PaaS) that allow customers to create, deploy, or run their own software applications” are excluded from the definition of digital products so would not be subject to California sales and use tax. CDTFA may provide more guidance in its emergency regulations.

Will California tax AI in 2027?

It could. CDTFA’s draft regulations include one example addressing AI. It reads:

“Company X is a computer software vendor that offers an Artificial Intelligence (AI)-powered tax-analysis tool within its prewritten compliance platform. The AI tool automatically generates recommended filing categories based on patterns the model has learned. To improve its predictions, Company X trains the AI tool on California’s sales and use tax statutes, regulations, and historical legal opinions. The result is a version of the tool that produces more accurate suggestions for California-based users.

Even though the AI tool produces outputs that appear tailored to California tax rules, these outputs are not the result of computer software prepared to the special order of a single customer. Instead, they are trained, automated outputs produced by a generalized machine-learning system that is sold or licensed to many customers. Therefore, such AI-generated adaptations do not qualify as custom computer software.”

Hopefully the Department will provide additional clarification or examples.

Will California tax digital services in 2027?

SB 122 provides a sales and use tax exemption for a digital product that represents a service provided in electronic form when 1) the service primarily involves the application of human effort by the service provider, and 2) the human effort originated after the customer requested the service.

But the bill also states that this exemption “does not apply to the sale or purchase of the right to use the provider’s computer software running on a cloud infrastructure or the right to access that software from various client devices through either a thin client interface, including a web browser, or a program interface.”

CDTFA should provide examples and guidance in its emergency regulations.

How does California determine where a digital product is taxed?

For in-person sales, the transaction is sourced to the seller’s location. For remote transactions, it’s sourced to the purchaser’s known address in California, using this priority order: the billing address, the shipping or delivery address, the mailing address associated with the payment instrument, or the purchaser’s most recent mailing address.

This article was updated on September 10, 2026.