The day has finally come: signed into law on June 29, 2026, SB 122 declares that “digital products” will be taxable as tangible personal property in California effective January 1, 2027. As the technology industry rapidly expanded in the past decade, California’s booming tech ecosystem benefited greatly from the state’s long-standing position that purchases and sales of software delivered electronically, such as prewritten code downloaded to a user’s device or accessed in a browser, is not subject to sales tax. Additionally, the term “Software as a Service,” also known as SaaS, was not a “retail sale of tangible personal property” and therefore not subject to California sales tax.
This era now ends with the passage of SB 122. SB 122 redefines how and when cloud-delivered software will be taxable in the state. If your company offers services relatively similar to those discussed, continue reading these key impacts and strategic considerations for SaaS providers, or reach out to us at info@milesconsultinggroup.com.
Why California and Why the Cloud?
The concept of digital products’ taxability is murky and changes from state to state. Under SB 122, Sec. 8, 6010.9. (a), the rule clarifies that “sale” and “purchase” do not include the design, development, writing, translation, fabrication, lease, or transfer of custom computer software (other than a basic operating system). SB 122, Sec. 8, 6010.9(b) defines key terms: a “computer” is any programmable electronic device with a CPU and memory; “computer software” is a set of coded instructions that directs such devices to perform tasks; and “custom computer software” is software specially ordered or modified for a single customer (excluding off-the-shelf products, except to the extent they are actually modified for that customer). SB 122, Sec. 10, 6016.1(a) defines a “Digital product” to include computer software transferred electronically or accessed remotely. SB 122, Sec. 10, 6016.1(b) states that digital books and digital video games, among other items, are not included in the definition of “digital products.”
As more states, under revenue pressure, expand their rules to tax cloud services, California faces a choice: keep cloud services non‑taxable and risk further budget strain and tax base erosion, or begin taxing cloud services and close what some may view as an unfair loophole.
Some of our readers may remember a time (not so long ago), when software was delivered via floppy disks or CDs that were shipped to consumers, which in California changed the sale from intangible to tangible and an obvious taxable transaction. The shift over the years to purely electronic delivery creates the ambiguity between nontaxable “services” and taxable “goods.” California regulators and courts generally leaned toward the exclusion of SaaS, with the resulting loss of revenue as the SaaS industry increases in operation.
The landmark administrative action that codifies SB 122 became a more serious discussion in late 2024, when the California Department of Tax and Fee Administration (CDTFA) opened a rulemaking proposal to redefine “tangible personal property” to include prewritten software accessed remotely.
How SB 122 Affects Technology Businesses
Software as a Service, digital products, and electronically delivered software (“EDS”) sold in California will now be subject to sales and use tax. Under Section 6, 6010.5. (b) (2), the provision states that the sourcing of electronically delivered digital products to the seller’s own in-state location whenever the sale is conducted in person at a site where the seller must hold a California seller’s permit (essentially a sale from a brick and mortar location). Otherwise, sales are sourced based on the following hierarchy:
- The purchaser’s billing address
- The purchaser’s shipping or delivery address
- The mailing address associated with the purchaser’s payment instrument
- The purchaser’s most recent mailing address
These services become part of the taxable measure, subject to the full 7.25 percent state rate and any local district taxes. SaaS vendors must now register in California, file returns, and remit the tax to CDTFA at the appropriate filing frequency, whether that be monthly, quarterly, or annually.
Will This Change Affect Nexus Thresholds?
The short answer is ‘Yes’. Remote sellers that meet the economic presence test in California, $500,000 of sales of tangible personal property (“TPP”) annually in the previous or current calendar year, must register and begin collecting as of January 1, 2027. SB122 has now expanded this threshold to include sales of digital goods and prewritten software.
Under Section 12. 6052. (a) (1) (A), sellers with over $5 million in annual sales of taxable digital products are relieved of collection duties, provided the purchaser holds a California Use Tax Direct Payment Permit. A “direct payment permit is “a permit issued by the board that allows a use tax direct payment permit holder to self-assess and pay state, local, and district use taxes under Part 1 (commencing with Section 6001), Part 1.5 (commencing with Section 7200), and, if applicable, Part 1.6 (commencing with Section 7251) directly to the board.” Under regulation 1699.6(a).
How to Incorporate SB 122 into Your 2027 Strategic Planning
To prevent any compliance mishaps, consider implementation of the following steps in your 2027 strategy:
- System readiness: Update billing and ERP systems to support California requirements.
- Geo-tracking and customer data to substantiate sourcing decisions.
- Consider the pricing and packaging revisions on your services for taxability.
- Begin the conversations with your customers now, before the updates are made in contracts.
- Monitor ongoing monitoring and compliance
In summary, this is a major change for California and will impact companies and consumers widely. In the next few months leading up to January 1, we will continue to share updates and filing nuances as companies grapple with the impact to their budget, systems, marketing, etc.
Also, stay tuned for the next update in this new series: Taxing the Cloud: State by State. Next up in our blog mini-series: Colorado! Until then, please reach out to us at info@milesconsultinggroup.com with any questions.
