California Expands Sales Tax to SaaS and Digital Products Under Senate Bill 122

California has enacted Senate Bill 122 (SB 122), introducing significant changes to the state’s sales and use tax regime by expanding the definition of taxable tangible personal property to include certain digital products. Effective 1 January 2027, many electronically delivered software products, including Software-as-a-Service (SaaS), will become subject to California sales and use tax.

The legislation also introduces new sourcing rules for digital products and includes several corporate and personal income tax measures aimed at increasing state revenues.

Digital Products Become Taxable

Under SB 122, the definition of tangible personal property is expanded to include qualifying digital products and related copyright or patent interests for sales and use tax purposes.

A digital product is generally defined as prewritten computer software that is:

• Delivered on tangible storage media;
• Transferred electronically; or
• Accessed remotely.

As a result, many software subscriptions and SaaS offerings that were previously outside the scope of California sales tax will become taxable from 1 January 2027.

Exclusions From the New Rules

Not all digital products are affected by the legislation.

The following remain generally excluded from the expanded definition:

• Custom software
• Cloud infrastructure services meeting specified conditions
• Digital audio products, including music
• Digital audiovisual content, including streaming services
• Digital books and e-books
• Video games
• Digital artwork
• Non-fungible tokens (NFTs)
• Digital products primarily representing human services

Additional exemptions also apply for qualifying resale transactions, certain reproduction rights and products used exclusively outside California.

New Sourcing Rules for Digital Products

SB 122 establishes specific sourcing rules to determine where digital product sales are taxable.

For software transferred electronically or accessed remotely, sales will generally be sourced to the customer’s billing address.

The legislation also provides sourcing rules for software delivered on tangible media and for in-person transactions, creating greater certainty for retailers selling digital products across multiple jurisdictions.

Collection Responsibility for Large Purchasers

The legislation introduces a special compliance framework for large purchasers of digital products.

Where a purchaser acquires more than $5 million of digital products annually from a retailer, the retailer may be relieved of its collection obligation. In these circumstances, responsibility for remitting California use tax shifts to the purchaser.

Additional Business Tax Measures

SB 122 also includes several income tax provisions.

The legislation:

• Extends California’s temporary $5 million business tax credit limitation through the 2029 tax year.
• Provides that, from 2030, business tax credits will generally be limited to the greater of $5 million or 70% of a taxpayer’s tax liability.
• Continues the election allowing taxpayers to convert certain limited tax credits into refundable credits under specified conditions.
• Reduces the first-year minimum franchise tax for qualifying partnerships, limited liability partnerships and limited liability companies from $800 to $400 for tax years beginning between 2027 and 2029.
• Imposes a 100% tax on payments received from the U.S. Department of Justice’s Anti-Weaponization Fund for tax years beginning between 2026 and 2029.

Compliance Considerations

The expansion of California’s sales tax base will require many businesses to reassess their indirect tax compliance processes before the rules take effect.

Businesses selling software or digital products to California customers should consider:

• Reviewing the taxability of software and digital offerings.
• Evaluating SaaS and bundled service arrangements.
• Updating ERP systems, billing platforms and tax engines.
• Validating customer location data to support the new sourcing rules.
• Assessing nexus and compliance obligations for remote sales.

These considerations apply not only to California-based businesses but also to out-of-state sellers with physical or economic nexus in the state.

Expected Revenue Impact

California estimates that the expansion of sales tax to digital products will generate approximately $1.4 billion in additional revenue during fiscal year 2027.

The legislation also aligns California more closely with the growing number of U.S. states that impose sales tax on remotely delivered prewritten software and SaaS.

Key Takeaways

• California will tax many SaaS and electronically delivered software products from 1 January 2027.
• The definition of tangible personal property has been expanded to include qualifying digital products.
• New sourcing rules generally apply based on the customer’s billing address.
• Several categories of digital products, including custom software and certain cloud infrastructure services, remain excluded.
• The legislation extends California’s business tax credit limitation through 2029 and introduces a permanent limitation from 2030.
• Businesses should begin preparing now by reviewing product taxability, sourcing rules and system configurations ahead of the implementation date.

Frequently Asked Questions (FAQ)

When do California’s new sales tax rules for SaaS take effect?

The new rules apply from 1 January 2027.

Is SaaS taxable in California under Senate Bill 122?

Yes. Many forms of prewritten software, including software accessed remotely through SaaS arrangements, will become subject to California sales and use tax.

Are all digital products taxable?

No. The legislation excludes several categories, including custom software, qualifying cloud infrastructure services, streaming services, e-books, music, NFTs, digital artwork and certain products primarily involving human effort.

How are digital product sales sourced?

For electronically delivered software, sales are generally sourced to the customer’s billing address.

What other tax changes are included in Senate Bill 122?

The legislation extends California’s business tax credit limitation through 2029, introduces a permanent limitation from 2030, reduces the first-year minimum franchise tax for certain entities and includes additional income tax provisions.