Starting January 1, 2027, California SB 122 makes most prewritten software and SaaS taxable. It also introduces new exemptions, nexus rules and tax obligations for buyers who purchase more than $5 million from one seller.
California is the home of big tech and was the largest U.S. market where software companies could sell products without collecting sales tax.
That changed with the passage of California Senate Bill 122 (SB 122), which became law on June 29, 2026. The new rules go into effect on Jan. 1, 2027, and fundamentally change the definition of tangible personal property to include prewritten (canned) software.
Traditionally, most tangible personal property is subject to sales tax under California law. Tangible personal property was long defined as “personal property which may be seen, weighed, measured, felt, or touched, or which is in any other manner perceptible to the senses.”
Now, the definition has been expanded to include all prewritten software, or programs “held or existing for general or repeated sale or lease,” including programs developed for in-house use but then sold or leased.
Under the new rules, digitally delivered software is now included in the definition of tangible personal property, making SaaS taxable in California.
This change is expected to bring in an estimated $2 billion annually and require many more companies, including SaaS companies, to understand nexus rules in California.
Below, we’ll talk about what SB 122 changed, why the reclassification matters, which products are now taxable and which stay exempt, how the new $5 million threshold shifts tax collection to buyers, and the best ways to prepare for this change.
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This is not pending legislation. Cal. S.B. 122, 2025–2026 Reg. Sess., ch. 23 (2026) was signed into law by Governor Gavin Newsom on June 29, 2026, as part of the state budget package. It is currently the law.
However, the collection of the taxes was pushed to Jan. 1, 2027, to give companies time to prepare.
This legislation closes a loophole that allowed a growing category of spending on digital goods to remain largely untaxed.
The table below shows the key changes:
Sales tax laws for SaaS vary across the country. Some states treat SaaS as a taxable good, while others treat it as a service and exempt it entirely.
California's rule shift is unique because it did not create a separate, standalone category of taxation for digital products. In fact, many digital products, including certain forms of digital text, audio, and video files, remain untaxed despite close physical analogs that are taxed.
Instead of creating a separate track for digital products, California simply expanded its definition of tangible personal property to include all canned or prewritten software, including digitally delivered programs.
There are many details for SaaS companies to learn, but here are a few key reasons this matters.
First and foremost, digitally distributed software will count when determining if a company meets California's $500,000 economic nexus threshold. Once a company's sales of tangible personal property in California exceed $500,000 in the current or preceding calendar year, it must register to collect sales tax.
Companies will also need to track the sale of digitally distributed and remotely accessed software into California, in addition to the software on physical media that already counted. Businesses that were once comfortably under the $500,000 threshold may now cross it without changing their product mix.
Businesses with physical nexus in California may already have nexus regardless of whether they cross the $500,000 economic nexus threshold.
Numeral offers free nexus monitoring, including tracking of SaaS and digital sales, so we can alert you when you reach the nexus threshold or are close to it. Once you've reached it, we can auto-register for you.
The second reason this change is important is that companies must collect tax on virtually all software sales, including SaaS subscriptions. Custom software other than a basic operational program, or software written directly for an end user, is the exception. It's still not subject to sales tax or counted in nexus calculations.
SB 122 also adds new and unusual requirements for buyers. The bill relieves sellers from liability for paying sales tax on electronically transferred or remotely accessed digital products when a single buyer's purchases of these products from that retailer exceed $5 million.
Once the $5 million threshold is exceeded, either during the current calendar year or, beginning Jan. 1, 2028, in the current or preceding calendar year, the tax obligation shifts to the purchaser unless the purchaser gets a waiver.
This $5 million rule doesn't shift liability for purchases made before the threshold was crossed. It applies to the transaction that causes purchases to exceed the threshold and to all subsequent covered transactions. It doesn't apply retroactively to any earlier purchases below the threshold.
While tax must now be collected on the sale of most software, SB 122 also expands potential exemptions as well. There are two new specific exemptions:
Exemptions written for tangible personal property may now also apply to software that they didn't cover before. California's manufacturing and R&D partial exemption, for example, has long listed computer software among the equipment used to operate or control qualifying machinery, but it was never a general software carve-out. A purchase still has to meet all of the exemption's other conditions.
Traditionally, when companies entered into technology transfer agreements (TTAs), physical property such as storage media or disks was taxable, while the software, as well as any copyrights or patents, was treated as intangible, and thus nontaxable, property.
However, with prewritten software treated as tangible taxable property after Jan. 1, 2027, any portion of a TTA that is attributable to software could now be subject to sales tax in California.
Staying compliant will mean understanding this change so that TTAs are handled correctly.
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While SB 122 made most digital software taxable, some digital tools remain exempt from sales tax under state rules.
Companies must know which goods and services they must collect and remit tax on and include in their nexus-tracking calculations.
Some software delivered on physical media was taxable prior to SB 122, so it is mostly digitally delivered software that is newly taxable, but not all digitally delivered software is included.
Specifically, software that is newly taxable includes:
Custom software is not subject to sales tax. As the law defines it, custom software is “computer software prepared to the special order of a single customer.” It “includes those services represented by separately stated charges for modifications to existing prewritten computer software that are prepared to the special order of the customer.”
However, software originally built to a particular customer's specifications but later offered for general sale isn't considered custom. And configurable platforms are also considered prewritten software. Only software written for a single end user's unique needs qualifies as custom.
If prewritten software is modified, this also does not make it custom software. The software itself is still taxed. Only the cost of the modifications that are separately stated on the invoice will be treated as non-taxable.
Some digital products and services are still not taxed. This may be because they are excluded from the statutory definition of “digital product,” or because a separate exemption applies.
Excluded products fall outside the expanded definition of tangible personal property. Examples include:
Products that are exempt may fall within the expanded definition of tangible personal property, but a carve-out excludes them from taxation. Examples include:
The statute specifies that the human-effort exemption doesn't let a buyer access a provider’s cloud-based software tax-free. The software won't become exempt just because the provider also sells services. This is important in mixed-component software contracts.
SB 122 requires a service-by-service analysis to determine whether services from cloud platforms, such as Azure, AWS, and Google Cloud, are excluded.
These cloud-based platforms sell many separate services, so taxability depends on the specific customer use case, including whether the customer can create, deploy, scale, or run their own software.
Most threshold-based rules governing sales and use tax trigger obligations for merchants. For example, reaching the economic nexus threshold triggers registration obligations and a duty to collect and remit sales tax. SB 122 sets up a different kind of threshold.
The law contains a unique provision that shifts the tax obligation to large software buyers. This is unusual, as California sales tax law almost always makes merchants responsible for filing and remitting taxes. However, the relevant language found in Sec 6052 in SB 122 states:
“A retailer is relieved from liability to pay sales tax on the sale or purchase of a digital product that is transferred electronically or accessed remotely if… the gross receipts from the sale of digital products by a retailer to a purchaser that are transferred electronically or accessed remotely exceed five million dollars ($5,000,000) in the aggregate in the current calendar year, or, beginning Jan. 1, 2028, in the current or the preceding calendar year.”
This means that as soon as one seller’s gross receipts from sales to a single buyer exceed $5 million in the current year or the prior calendar year (starting January 2028), that buyer becomes responsible for covering the tax on the entire transaction that exceeded the threshold.
For example, let's say a buyer has spent $4.9 million on a workforce planning platform and then receives a $300,000 invoice. The purchaser has now exceeded $5 million and is responsible for the use tax on the entire $300,000 invoice, not just the $200,000 above the limit.
The rule doesn't apply retroactively, though. The buyer becomes responsible only for the sale that exceeded the threshold, and all subsequent sales. The seller still must remit sales tax on prior sales.
Once the purchaser becomes responsible for the tax, the purchaser must obtain a use tax direct payment permit, unless the CDTFA grants a waiver that leaves collection to the seller.
The buyer must identify any places of business expected to be places of first use to the CDTFA to be eligible for this waiver. They must also submit those places of business to the retailer. The process of obtaining one operates outside of the traditional CDTFA rules for direct pay permits found in Regulation 1699.5.
The $5,000,000 threshold is indexed to inflation based on the California Consumer Price Index for All Urban Consumers and will be adjusted every five years, with the first adjustment calculated on or before October 1, 2031, and taking effect Jan. 1, 2032.
Pro Tip: Buyers are rarely obligated to pay sales tax directly, so companies making large software purchases must be aware of the unusual SB 122 requirement to ensure compliance.
In many cases, the buyer and seller are not in the same geographic location. When that happens, sales tax sourcing rules determine which geographic location's rules apply to determine if the item is taxable and at what rate.
Under SB 122, the place of use is the key factor in determining whether an item is subject to sales tax. A digital product purchased outside California and used in the state within 90 days of the sale is presumed to have been purchased for use in California, so SB 122 applies.
When sales tax applies, in-person sales are taxed based on the seller's place of business. For remote purchases or products delivered electronically, the sale is sourced to the purchaser's known address. Sellers must obtain the customer's address in good faith from the seller’s business records.
A specific hierarchy determines which location applies to a buyer. Specifically, the first one of these addresses that is known is treated as the location where the sale is sourced to:
SB 122 also acknowledges that when multi-state customers purchase SaaS seats or software licenses, and only a portion of the seats are used by California employees, the company shouldn't pay tax on the full number of seats purchased.
However, the legislation authorizes CDTFA to create a method for apportioning tax on products used concurrently in multiple locations but doesn't expressly provide a formula or instructions for calculating the percentage of the sale that is taxable in these situations.
While CDTFA has already been working on many aspects of the rulemaking for how the new tax rules will be enforced, two main issues remain unresolved:
The CDTFA held a meeting on Sept. 10, 2026, to consider regulations implementing SB 122, including Regulation 1600.2 covering digital products purchased for multiple points of use.
They are currently accepting comments, suggestions, and proposed language. The CDTFA Business Taxes Committee Section page tracks the proposed regulations and meeting materials.
Smart companies will prepare for SB 122 before Jan. 1, 2027. Taking these steps will help to ensure you remain in full compliance once the rules go into effect:
Numeral monitors changes to the law, such as SB 122, and ensures your company stays compliant.
Our free nexus monitoring across all 50 states ensures every taxable sale is counted and calculated, and you're alerted when you establish nexus. We'll register for you, file your returns, and remit your taxes, and a U.S.-based tax expert reviews every return.
No long-term commitment is required, and you pay a simple flat rate of $75 per filing and $150 per registration. The Numeral Guarantee also provides peace of mind: your sales tax is filed on time, or we’ll pay your penalties and interest.
Get started with Numeral today or book a demo to learn more.
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