California to tax software and SaaS in 2027

• 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.
• SB 122 provides sourcing rules. The sourcing rules detailed in SB 122 are similar to sourcing rules adopted by many other states.

SB 122 taxes 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.

The bill 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.”

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:
   1. The purchaser’s billing address
   2. The purchaser’s shipping or delivery address
   3. The mailing address associated with the purchaser’s payment instrument
   4. The purchaser’s most recent mailing address

If the purchaser didn’t provide an address, use addresses previously provided by the purchaser to the seller in the following order of priority:

1. The purchaser’s most recent billing address
2. The purchaser’s most recent shipping or delivery address
3. The purchaser’s most recent mailing address associated with the purchaser’s payment instrument
4. The purchaser’s most recent mailing address

These are similar to the sourcing rules recommended by the Streamlined Sales Tax Governing Board and many states. Read this state-by-state guide to the taxability of digital products for more on the sourcing of digital transactions.

SB 122 doesn’t allow businesses to allocate tax to account for software or SaaS used outside of California. But it does shift 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.

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.

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.