California expands sales tax to software: What businesses need to know
- Starting January 1, 2027, California will begin taxing many software transactions, including SaaS subscriptions, cloud-based software access and electronically delivered prewritten software.
- Certain digital products, including digital books, audiovisual content, video games, some digital infrastructure offerings and cryptographically secured digital assets, generally remain exempt.
- Software providers may need to update billing systems, tax collection processes, contracts and sourcing methodologies. Software purchasers should evaluate increased tax costs, budgeting implications and multistate use tax compliance ahead of the 2027 effective date.
With the passage of Senate Bill 122, California has enacted one of its most significant sales and use tax changes in years. Beginning January 1, 2027, the state will begin charging sales tax on many software transactions that historically weren’t taxed.
The change is expected to generate nearly $900 million in annual revenue and will affect both software providers and businesses that purchase software in California.
Here are the key provisions businesses should be paying attention to.
1. SaaS and electronically delivered software will generally become taxable
Historically, California sales tax primarily applied to transfers of tangible personal property. Many cloud-based software and electronically delivered software transactions fell outside the tax base.
Starting in 2027, California will treat certain digital software products as tangible personal property for sales and use tax purposes. As a result, sales tax will generally apply to:
- Prewritten software delivered electronically
- Software accessed remotely through the cloud
- Software-as-a-service (SaaS) subscriptions and similar software offerings
- Software delivered on physical media
This represents a significant shift for businesses that historically have not collected or paid California sales tax on these transactions.
2. Not all digital products are taxable
While the legislation significantly expands the taxation of software, it does not create a broad tax on all digital products.
The following products generally remain outside the scope of the new law:
- Digital books
- Digital audiovisual works
- Video games, including those transferred electronically or accessed remotely
- Certain digital infrastructure offerings
- Cryptographically secured digital assets
Custom software transactions also generally remain excluded.
3. Certain exemptions remain available
Although the law significantly expands the tax base, several important exclusions and special rules remain.
Examples include:
- Temporary storage of software in California for deployment and use outside the state
- Certain software resale transactions involving “golden masters”
- Multiple-points-of-use provisions and credits for tax paid to other states
Additional guidance is expected from the California Department of Tax and Fee Administration (CDTFA) on how these provisions will be administered.
4. Local taxes can increase the overall tax burden
The impact extends beyond California’s statewide sales tax.
Because local and district taxes generally follow the state tax base, taxable software transactions may also be subject to local taxes, potentially increasing the overall tax rate depending on the consumer’s location.
The legislation establishes sourcing rules designed to determine the appropriate local jurisdiction for electronically delivered and remotely accessed software.
5. Technology transfer agreements are affected
The legislation also changes the tax treatment of certain software technology transfer agreements (TTAs).
For agreements entered into on or after January 1, 2027, favorable exclusions previously available for qualifying software transactions may no longer apply. In addition, certain ongoing lease arrangements may become taxable for payments due on or after the effective date.
CDTFA is also expected to provide more guidance on how these provisions will be administered.
6. Retailer relief for large sales to single customers
If a retailer sells more than $5 million of taxable software or other digital products to the same customer during a calendar year, the retailer is not required to charge California tax on those sales. Instead, the purchaser becomes liable for remitting the tax on those transactions. Beginning January 1, 2028, the $5 million threshold will be based on purchases made during either the current or prior calendar year.
What should businesses do now?
While the new rules do not take effect until January 1, 2027, businesses should begin evaluating the potential impact now.
Software providers should consider whether updates are needed to:
- Tax collection procedures
- Billing and invoicing systems
- Customer contracts
- Customer location sourcing methodologies
Businesses purchasing software should evaluate:
- Increased sales and use tax costs
- Use tax accrual processes
- Budget impacts
- Multi-state software usage considerations
Businesses that buy or sell software in California should review their contracts, systems and tax processes well before January 1 and monitor future CDTFA guidance as implementation details continue to develop.
How Wipfli can help
California’s new rules will significantly expand the sales tax treatment of software. Wipfli's state and local tax team can help you evaluate the impact on your business, identify potential planning opportunities and prepare your systems and processes for compliance. Let’s talk about how these changes may affect your organization and what steps you can take now to prepare. Start a conversation.
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