Partner Hillary Alexander, CPA, Explains California's New SaaS Tax

California taxing SaaS is one of the biggest US software changes in years.

On June 29, 2026, Governor Gavin Newsom signed Senate Bill 122 (SB 122), a budget trailer bill that extends California's sales and use tax to digital products, including prewritten software and Software as a Service (SaaS). The change takes effect for transactions occurring on or after January 1, 2027.

California was one of the few large states that did not tax electronically delivered or cloud-accessed software. That exemption is going away. If your company sells software into California, or buys it for use there, this affects you, whether or not you are based in the state.

What is now taxable

Beginning January 1, 2027, California's full state and local sales and use tax (7.25% state rate, plus local district taxes that vary by buyer location) applies to prewritten software regardless of how it is delivered. That includes software:

• Software shipped on a disk or other physical media
• Software downloaded electronically
• Software accessed remotely — this is the big one, and it covers SaaS and other cloud subscription tools
• AI tools, which California treats the same way it treats any other prewritten software

The law amends California's definition of "tangible personal property" to include digital products. In plain terms, the format no longer matters. If it is prewritten software, it is taxable.

What stays exempt

Not everything digital is swept in. SB 122 preserves several important exclusions:

• Custom software — built to a specific customer's order. If you modify prewritten software for a client, only the separately stated modification charge qualifies as exempt custom work; the underlying product is still taxable.
• Infrastructure and platform services (IaaS/PaaS) — think AWS, Microsoft Azure, and Google Cloud. If a customer is running their own software on someone else's infrastructure, that's excluded.
• Other digital goods — digital books and newsletters, music and streaming media, video games, and digital assets like cryptocurrency.

The key dividing line is "prewritten" versus "custom." If you sell the same software to many customers, it's almost certainly prewritten and taxable. If your software was built from scratch for one client, it's custom and stays exempt. Modifications to prewritten software are a gray area: the modification itself may qualify as custom, but the underlying prewritten product remains taxable.

Do I have nexus?

Two things must be true. First, what you sell must qualify — prewritten software or SaaS, not custom software or infrastructure services. Second, you need a connection to California, known as “nexus,” which happens either way:

• Economic nexus: California’s economic nexus threshold is $500K of sales in the current or prior calendar year, with no transaction-count threshold.
• Physical nexus: a California office, employees, or property in the state.

Not having a California office does not get you off the hook. A lot of software companies that have never registered in California will need to for the first time based on Economic nexus.

Sales vs Use tax

There are two primary types of indirect taxes in the U.S. Both are taxes on the same thing, but differ on who is responsible for paying it:

• Sales Tax: Collected by and responsibility of the seller because of their nexus in the state.
• Use Tax: Responsibility of the customer. Seller doesn’t have nexus (or at least didn’t charge sales tax) but the goods/services are subject to sales/use tax.

What about my exempt and resale customers?

Some B2B customers, including resale buyers and qualifying exempt entities, won't owe California tax. But you can only skip charging them if you have a valid California exemption or resale certificate on file. Without one, you must charge them. Identify those customers and collect certificates before January 1.

The $5 million wrinkle: liability can shift to the buyer

SB 122 includes a mechanism most states do not have. For large software relationships, the obligation to remit tax can move from the seller to the purchaser.

If a retailer's gross receipts from digital product sales to a single purchaser exceed $5 million in the applicable period, the purchaser assumes responsibility for self-assessing and remitting use tax rather than the seller collecting it. If your business has large software vendors or large software customers, model this threshold now.

How to prepare before the deadline

Six months is less runway than it sounds like, because system changes, contract updates, and registrations take time. Practical steps:

• Confirm your nexus. Determine if you have physical nexus or whether you cross the $500,00 economic nexus threshold. If you're close or already over, you'll need to register with the California Department of Tax and Fee Administration (CDTFA). Registrations can be submitted up to 90 days before the effective date.
• Map your offerings and purchases. Review your product catalog against the prewritten-versus-custom line. If you offer bundled products or have configurable platforms, those require closer analysis.
• Test your billing and tax systems. California's rate isn't uniform. It's 7.25% state plus local district taxes sourced to the buyer's California location. Your system needs to know where each customer is, calculate the right combined rate, and add it to their invoice automatically from day one.
• Handle exemption certificates. Identify your California B2B customers who may qualify for exemptions. Collect valid California exemption or resale certificates before January 1.
• Model the $5 million threshold. Identify vendor and customer relationships that could trigger the liability shift.
• Review contracts that staddle January 1, 2027. This is a gray area. Understand your exposure.
• Inform you customers. Buyers will see a new tax line item on their invoices starting January.

Guidance is still coming

SB 122 leaves several questions open, including the exact line between custom and prewritten software, bundled transactions, resale treatment, and transition rules for multi-year contracts that straddle the effective date. The California Department of Tax and Fee Administration (CDTFA) is expected to issue clarifying guidance, with a workshop scheduled for Tuesday, July 21, 2026. Until then, taxpayers should document their positions and the facts supporting them.

How we can help

If your business sells or buys software or SaaS with any California footprint, now is the time to assess your exposure. Our team can help you classify your offerings, evaluate your systems and contracts, and build a compliance plan well ahead of the deadline.

Reach out to your Brinker Simpson tax advisor to start the conversation.