For decades, California taxed software only when it came in a box. A program on a disk was taxable, while software that was downloaded or run in a browser generally escaped the tax. That ends on January 1, 2027. SB 122, a tax budget trailer bill signed on June 29, 2026 as Chapter 23 of the Statutes of 2026, adds “digital products” to the definition of tangible personal property, which pulls software as a service, downloaded software, and most remotely accessed prewritten software into the sales and use tax. Colorado reportedly passed a similar law weeks earlier with the same effective date. For software sellers in Sacramento and for every Inland Empire business that pays monthly subscriptions, the next four months are the planning window.
What does SB 122 make taxable?
The bill amends Revenue and Taxation Code § 6016 so tangible personal property includes a digital product, and new § 6016.1 defines a digital product as prewritten computer software transferred on tangible storage media, transferred electronically, or accessed remotely. Software first developed for one customer becomes “prewritten” once it’s held for general sale. The definition then carves out several categories: digital assets, audio and audiovisual works, books, video games, visual works, and “digital infrastructure,” meaning cloud services that let a customer create, deploy, scale, or run its own software. That last exclusion is how the bill treats most infrastructure-as-a-service and platform-as-a-service offerings.
Local and district taxes follow the state tax. The bill amends the Bradley-Burns and district tax statutes so remote sales of digital products are sourced to the purchaser’s address, which means the rate depends on where the customer is, not where the seller is. You can read the full text on the Legislature’s bill page for SB 122.
What stays exempt?
Software built to one customer’s order is still treated as exempt custom software. New § 6372 exempts products bought only for use in other states or in interstate or foreign commerce; the seller carries the burden of proof unless it takes an exemption certificate from the buyer. A buyer with users both inside and outside the state can issue a certificate and self-report use tax on the California portion, though the statute doesn’t say how to split it.
The most debated provision is new § 6372.1, the “human effort” exemption. It covers a digital product that represents a service delivered electronically, where the service primarily involves human effort by the provider and that effort begins after the customer asks for it. The same section says the exemption doesn’t apply to the right to use or access the provider’s software running on cloud infrastructure, whether through a web browser or a program interface. At its July 21, 2026 workshop, the California Department of Tax and Fee Administration reportedly framed the question as one of the “true object” of the transaction and acknowledged it hadn’t yet defined how much human effort is enough. A medical billing firm whose coders work claims and report through a portal has a plausible argument. A practice-management platform the client logs into and runs itself doesn’t.
| Transaction after January 1, 2027 | California sales or use tax? | Where it comes from |
|---|---|---|
| SaaS subscription to prewritten software used in California | Taxable | RTC §§ 6016, 6016.1 |
| Downloaded prewritten software | Taxable | RTC § 6016.1 |
| Custom software written for one customer | Exempt | RTC § 6010.9 |
| Cloud infrastructure a customer uses to run its own software (IaaS, PaaS) | Excluded as digital infrastructure | RTC § 6016.1 |
| Service performed mainly by people and delivered electronically after a request | Possibly exempt; guidance pending | RTC § 6372.1 |
| Software purchased solely for use outside California, with certificate | Exempt | RTC § 6372 |
| E-books, streaming audio or video, video games | Excluded from “digital product” | RTC § 6016.1 |
Who has to collect the tax, and when does a buyer pay it directly?
An out-of-state seller must register and collect once its California sales exceed $500,000 in the current or preceding year under § 6203(c)(4). A California-based seller needs a seller’s permit regardless. Whether 2026 subscription revenue, which isn’t taxable yet, counts toward the 2027 threshold is one of many questions CDTFA hasn’t answered.
SB 122 also flips collection responsibility for very large buyers. Under new §§ 6052 and 6201.55, once a single customer’s annual digital product purchases from a single vendor top $5 million, the customer rather than the vendor self-assesses and pays the tax directly to CDTFA. Starting in 2028, the prior year’s purchases also count. That rule will mostly affect large employers and hospital systems, but mid-market buyers of enterprise software should track it.
The more common exposure is use tax on vendors that never register. Under § 6202, a California purchaser owes use tax when the seller doesn’t collect it. And through 2028, § 6225 requires a business that isn’t otherwise registered with CDTFA to register as a qualified purchaser and file by April 15 once it has more than $10,000 of purchases subject to use tax. Many small professional firms in Riverside and San Bernardino counties have never registered, because they’ve never bought much taxable equipment from out of state. A few software subscriptions from small vendors could change that.
What will this cost a Temecula business or a Sacramento software company?
Start with a Temecula medical billing company that spends $180,000 a year on SaaS. Temecula’s combined rate is 8.75%, according to CDTFA’s April 2026 rate schedule, so if every vendor collects, the company pays $15,750 a year in new tax. If a fifth of its seats are used by remote billers in Arizona and it gives vendors an out-of-state use certificate while self-reporting the California share, the tax on the remaining $144,000 is $12,600, though that split is exactly the kind of allocation CDTFA hasn’t blessed yet. If $60,000 of its software comes from small out-of-state vendors that don’t register, it owes $5,250 of use tax itself, and because those untaxed purchases exceed $10,000, it has to register and file a qualified purchaser return. The tax is a deductible business expense for income tax purposes, which softens the cost but doesn’t eliminate it.
Now take a Sacramento startup selling $2 million of subscriptions a year, 40% to California customers. At an 8.75% rate across its California customers, that’s $70,000 of tax, and the actual figure depends on each customer’s address. Who bears it depends on the contract. Civil Code § 1656.1 makes a seller’s right to add sales tax reimbursement depend on the terms of the sale. If the company’s master agreements state tax-included prices, about $64,400 of the $800,000 is tax that comes out of revenue. If they say nothing about tax, the company owes tax on the full $800,000 and may be unable to pass the $70,000 through. On the income tax side, the same California customers already drive its Franchise Tax Board sales factor under market-based sourcing, so the company will now report the same revenue to two state agencies.
What happens to contracts that run past January 1, 2027?
SB 122 contains no transition rule for existing contracts and no rule for bundled software and services. At the July workshop, CDTFA reportedly said a taxable sale requires a right to use the software and consideration after the effective date, and it didn’t commit to whether the contract date or the payment date controls a multiyear deal. That makes year-end prepayments risky. An annual subscription invoiced and paid in December 2026 for calendar 2027 service may still be taxed, and a company that prepays three years to “beat the tax” could find it bought nothing but an audit issue. CDTFA has reportedly circulated draft emergency regulations for discussion and expects to adopt rules before the effective date, so businesses should watch its special notices page.
Until the regulations arrive, there’s still plenty to do. Sellers should update contract templates to state that prices exclude tax and that the customer reimburses applicable tax, separate human-effort services and infrastructure from software access on invoices, and start collecting reliable billing and service addresses for every customer now. Buyers should list every software vendor, flag which ones are likely to collect, and budget the tax at their local rate. Businesses with teams outside California should decide how they’ll document out-of-state use before signing their 2027 renewals.
How did California treat software before, and why does it matter now?
Under Cal. Code Regs., tit. 18, Regulation 1502(f), prewritten software delivered by remote telecommunication without any tangible property changing hands wasn’t taxable. Sellers also relied on the technology transfer agreement rules; in Nortel Networks Inc. v. State Board of Equalization (2011) 191 Cal.App.4th 1259, the Court of Appeal held that the value of copyright and patent interests transferred in certain software licenses wasn’t subject to sales tax. SB 122’s amended definition expressly includes “any copyright or patent interests associated” with a digital product, which reads like a response to that line of argument. Anyone with an open refund claim or audit involving pre-2027 software transactions should keep those older rules in view, because the new law is prospective.
Frequently Asked Questions
Is SaaS taxable in California?
Starting January 1, 2027, yes. SB 122 treats prewritten software accessed remotely as a taxable digital product, subject to state and local sales or use tax at the customer’s location.
Is cloud hosting or infrastructure taxable under SB 122?
Services that let a customer create, deploy, scale, or run its own software are excluded as “digital infrastructure,” which generally covers IaaS and PaaS. Bundled offerings may need allocation.
What is the human effort exemption?
It exempts services delivered electronically that primarily involve the provider’s human effort, performed after the customer’s request. It doesn’t cover access to the provider’s software, and CDTFA hasn’t yet defined how much human effort is required.
Do I owe use tax if my software vendor doesn’t charge California tax?
Yes. The purchaser owes use tax when the seller doesn’t collect it, and through 2028 a business with more than $10,000 of such purchases must register with CDTFA as a qualified purchaser.
Will prepaying a 2027 subscription in 2026 avoid the tax?
Not reliably. SB 122 has no transition rule, CDTFA has reportedly tied taxability to use rights and consideration after January 1, 2027, and it hasn’t said whether the contract date or the payment date controls.
Which rate applies to a SaaS subscription?
The combined state and local rate at the purchaser’s address in the seller’s records. For example, CDTFA lists 8.75% for Riverside, Temecula, Ontario, and Sacramento as of April 2026.
How North Star Law Firm Can Help
North Star Law Firm helps California businesses and software companies prepare for SB 122, including taxability reviews, contract tax clauses, qualified purchaser registration, and CDTFA audits and appeals. Phillip Zagotti is a California attorney and a CPA, so a sales tax review can cover the contract language, the invoice structure, and the income tax sourcing together. Learn more about the firm’s sales and payroll tax practice, its tax defense work, and its contract drafting and review, or schedule a consultation to plan for your 2027 renewals.