California Just Made SaaS Taxable. Every Software Company Has 87 Days to Prepare
For nearly three decades, selling software to California customers was simple from a sales tax perspective.
You didn't collect it. California treated remotely accessed software as a service — not a product — and services weren't taxable. SaaS companies could sell subscriptions to millions of California customers without a sales tax obligation. The state was one of the easiest markets in the country for software compliance.
That ends on January 1, 2027.
Governor Gavin Newsom signed Senate Bill 122 on June 29, 2026 as part of California's 2026-2027 budget. Starting January 1, SaaS subscriptions, downloaded software, and cloud-accessed prewritten software all become taxable tangible personal property under California law. The full state and local combined rate — 7.25% state plus local district taxes that vary by buyer location — applies to every qualifying transaction from the first day of the year.
87 days. Here's everything you need to know.
What SB 122 Actually Does
California's law amends the state's definition of tangible personal property to include digital products — specifically prewritten computer software regardless of how it is delivered. As BDO's analysis of California SB 122 confirms, the law imposes sales and use tax on retail sales of digital prewritten software, including SaaS, regardless of how it is delivered — physical media, electronic download, or remote access.
That last category — remote access — is the one that changes everything for SaaS companies. Before SB 122, a customer accessing software through a browser was accessing a service. Under SB 122, that same customer is purchasing tangible personal property. The delivery method didn't change. The legal classification did.
The law also explicitly covers AI tools — California treats AI products the same way it treats any other prewritten software. If you sell an AI-powered product accessed through a browser or API, it's taxable from January 1.
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What's Taxable — The Full List
Under SB 122, the following are taxable in California starting January 1, 2027:
SaaS subscriptions — any subscription to prewritten software accessed remotely through a browser, thin client, or program interface. Downloaded prewritten software — software transferred electronically to the customer's device. Hosted applications — prewritten software running on vendor infrastructure that the customer accesses remotely. AI tools — treated identically to other prewritten software under SB 122.
As Taxwire's California SaaS sales tax analysis notes, there is no blanket B2B exemption under SB 122. A SaaS company selling to enterprise customers pays the same tax as one selling to consumers. The buyer being a business doesn't create an exemption — only specific product category exemptions or valid exemption certificates do.
What's Exempt — The Details That Matter
This is where SB 122 is more nuanced than most coverage suggests. Several significant categories remain outside California's sales tax net after January 1.
Custom software — software written specifically for a single customer's unique needs — remains exempt. The exemption is narrow: as Ceretax's SB 122 analysis confirms, only software written for a single end user's unique needs qualifies as custom. If you modify prewritten software for a client, only the separately stated modification charge qualifies as exempt custom work. The underlying prewritten product is still taxable.
Infrastructure-as-a-Service and Platform-as-a-Service — IaaS and PaaS without a prewritten software component remain exempt. The digital infrastructure exclusion doesn't apply to SaaS, but pure infrastructure services — compute, storage, networking — stay outside the tax base.
Human-effort services delivered electronically — SB 122 exempts services where the service primarily involves the application of human effort by the service provider and the human effort originated after the customer requested the service. Professional consulting services, data processing services, and similar human-delivered services remain exempt.
Digital goods that aren't software — ebooks, digital music, video content, video games, digital assets including cryptocurrency — all remain exempt under SB 122. The law is specifically targeted at prewritten software, not digital goods broadly.
Software used exclusively outside California — an exemption exists for digital and software products exclusively used outside California. If your software is purchased for use entirely outside the state, no California sales tax applies.
The $5 Million Self-Remittance Threshold — The Most Overlooked Detail
This is the provision that most SB 122 coverage misses — and it has significant implications for enterprise SaaS sellers.
As Numeral's California SB 122 analysis confirmed, SB 122 introduces new and unusual requirements for buyers. If a buyer's aggregate purchases of digital products from a single seller exceed $5 million in a calendar year, the seller is relieved of the obligation to collect tax on that buyer. The buyer becomes directly liable for use tax and must self-assess and remit it directly to the CDTFA — and must obtain a use tax direct payment permit.
In plain terms: your largest California enterprise customers — the ones buying more than $5 million of your software annually — handle their own tax compliance directly with the state. You don't collect from them. They pay the state directly.
This creates a specific compliance workflow for SaaS companies with large California enterprise accounts. You need to know which customers are approaching the $5 million threshold, notify them when they cross it, and stop collecting tax on those accounts. The CDTFA will be issuing guidance on how this process works — watch for it before year-end.
The Nexus Shift — Why This Catches SaaS Companies Off Guard
Here's the detail that is catching the most SaaS companies off guard — because it affects whether they have any California obligation at all.
Before SB 122, SaaS sales in California were not taxable — which meant they also didn't count toward California's $500,000 economic nexus threshold. A SaaS company with $2 million in California subscription revenue had no California sales tax obligation and no nexus — because non-taxable sales don't count toward the threshold.
Under SB 122, that same $2 million in California SaaS revenue is suddenly taxable — and suddenly counts toward the nexus threshold. As Taxwire's SB 122 compliance analysis notes, SB 122 does not create a new nexus test, but it makes software sales count toward the existing one — so many SaaS companies will be registering with California for the first time.
A SaaS company with $600,000 in California subscription revenue has California nexus starting January 1, 2027. It needs to register with the CDTFA, configure its billing system to collect tax on California customers, and begin filing California sales tax returns — all by January 1.
The Multi-Year Contract Problem
One more detail worth flagging specifically: multi-year software contracts that cross the January 1, 2027 effective date.
If you signed a two-year SaaS contract with a California customer in mid-2026 — before SB 122 was signed — and that contract runs through mid-2028, the portion of the contract after January 1, 2027 is taxable. The pre-SB 122 contract price may not have included California sales tax. You may now owe tax on post-January 1 billing periods that your customer's contract doesn't account for.
Review every multi-year California customer contract. Understand which billing periods fall before and after January 1. Assess whether your contract language allows you to pass the sales tax through to the customer — or whether you'll absorb it.
What the Rate Actually Is — Not 7.25%
One more common misunderstanding worth correcting.
California's statewide rate is 7.25%. But that's not what California customers pay on SaaS from January 1. They pay the full combined rate for their location — state rate plus applicable district taxes.
A customer in San Francisco pays 8.625%. A customer in Los Angeles — now subject to Measure ER — pays 10.25% or higher. A customer in Santa Monica pays 11.25%. The rate varies by the buyer's location, which is why address-level rate calculation is essential.
As Brinker Simpson's analysis of SB 122 confirms, 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 beginning January 1, 2027. You collect the rate for where the customer is, not where you are.
The 87-Day Compliance Checklist
January 1 is 87 days away. Here's what needs to happen before then.
Audit your product catalog. Classify every product you sell — prewritten software or SaaS is taxable, custom software is exempt, IaaS and PaaS may be exempt, AI tools are taxable. Mixed bundles of taxable and exempt components need to be split and priced separately.
Determine your California nexus status. If you have more than $500,000 in California software revenue — counting SaaS subscriptions that were previously non-taxable — you have California nexus starting January 1. Register with the CDTFA now. The registration process takes time.
Configure your billing system for address-level California rates. The rate is different in San Francisco, Los Angeles, Santa Monica, and San Jose. Your billing platform needs to calculate the correct combined rate for each customer's address — not a flat California rate.
Collect exemption certificates from qualifying customers. Businesses that claim a resale exemption or manufacturing exemption may have valid certificates on file. Collect and validate them before January 1.
Identify customers approaching the $5 million threshold. Begin tracking which enterprise accounts are on track to exceed $5 million in annual software purchases from you. Prepare the notification and transition process for those accounts.
Review multi-year contracts. Flag every California contract that extends past January 1, 2027. Assess the tax treatment of post-effective-date billing periods and whether your contract language addresses the new obligation.
Update your customer communications. California customers will see a new sales tax line on their January invoices — many for the first time. Prepare a communication explaining the change so customer service teams can handle the questions proactively.
Not sure whether your SaaS products are taxable under SB 122, whether you have California nexus, or how to configure your billing for January 1? Book a free consultation with our team at sales.tax. We'll walk through your specific product catalog, your California revenue, and your compliance setup — so January 1 isn't a surprise.
What this means for your business
If your sales into California have grown with prices, you may have crossed the economic nexus threshold without changing anything about how you sell. We’ll tell you where you stand in 30 minutes — and if there’s nothing to fix, we’ll say so.