The Party's Over: After More Than Three Decades, California Will Begin Taxing SaaS

Gov. Gavin Newsom on June 29, 2026, signed Senate Bill 122 (SB 122, Chapter 23), a budget trailer bill that, among other provisions, extends California's sales and use tax to "digital products," defined as prewritten computer software transferred electronically or accessed remotely. This marks a significant shift in California tax policy. For the first time, software-as-a-service (SaaS) and other remotely accessed software will be subject to California sales tax, effective January 1, 2027. With this change, California joins more than 20 states that tax SaaS in some form.

Key Definitions

SB 122 amends Revenue and Taxation Code Section 6016 to redefine "tangible personal property" to include "a digital product and any copyright or patent interests associated therewith." This is the definitional hook that brings remotely accessed software within the scope of California's existing sales and use tax framework.

Under new Section 6016.1, a "digital product" is "prewritten computer software transferred on tangible storage media, transferred electronically, or accessed remotely." However, the statute excludes from the definition of "digital product": digital assets (cryptocurrency), digital audio and audiovisual works (music and streaming video), digital books, digital video games, digital visual works and, significantly, "digital infrastructure" (infrastructure as a service, or IaaS, and platform as a service, PaaS, offerings where the customer deploys and runs its own software on the provider's platform). Notably, this formulation breaks from the treatment of digital products under the Streamlined Sale and Use Tax Agreement and definitions thereunder that have been adopted by a number of states.

The statute defines "prewritten computer software" as software "held or existing for general or repeated sale or lease," even if originally developed on a custom basis. Software is considered "accessed remotely" when it resides on the vendor's or a third party's server and is accessed by use of a digital code, password or similar means.

Exemptions and Special Rules

• Custom Software Exemption: California's existing exemption for custom computer software (software "prepared to the special order of a single customer") is preserved. However, the exemption does not apply to software "held or existing for general or repeated sale or lease, even if initially developed on a custom basis."
• Out-of-State Use Exemption: Digital products purchased solely for use outside California or in interstate or foreign commerce are exempt. Sellers may accept a certificate attesting to out-of-state use. However, unlike some other states that tax SaaS, the California legislation does not contain a method for allocating use on a multistate basis.
• Human Effort Services Exemption: Digital products representing services "primarily involving the application of human effort" that "originated after the customer requested the service" are exempt, but this exemption explicitly does not apply to SaaS access rights.
• Large Purchaser Self-Assessment: When sales of digital products from a single retailer to a single purchaser exceed $5 million annually, the retailer is relieved of sales and use tax collection obligations, and the purchaser must self-assess and remit the tax directly to the California Department of Tax and Fee Administration (CDTFA).

Sourcing of Digital Products

The place of the sale or purchase of a digital product transferred electronically or accessed remotely is deemed to be the purchaser's known address in California as shown in records maintained by the seller in good faith in the ordinary course of business. If a purchaser provides more than one address, the purchaser's known California address is determined according to the following order of priority: 1) the purchaser's billing address, 2) the purchaser's shipping or delivery address, 3) the mailing address associated with the purchaser's payment instrument and 4) the purchaser's mailing address.

California defines the "place of use" of a digital product as "the place where any right or power is exercised over the digital product." Further, the statute explains that "the right or power to remotely access a digital product is exercised at the place where the person accessing the digital product is located." Finally, there is a presumption of California use for a digital product purchased outside California and used in the state within 90 days from the date of sale or purchase.

Holland & Knight Insight

Open Questions

Several issues remain unresolved or ripe for controversy:

• The exclusion for "digital infrastructure" (IaaS and PaaS) may create challenges for cloud offerings with hybrid characteristics, where the line between taxable SaaS and an exempt platform on which customers run their own software is unclear.
• Highly configurable SaaS platforms may face uncertainty under the custom software exemption, which does not apply to software "initially developed on a custom basis" but is now held for general sale.
• Businesses offering bundled services, such as implementation, training and support alongside software access, will need CDTFA guidance on how to allocate charges between taxable and potentially exempt components.
• The human effort exemption is likely to cause disagreement as controversy arises over the amount of "human effort" necessary to fall within the exemption.

The 90-day rule is likely to cause disputes over the first use outside of the state as well as the intent of use as it relates to California.

Compliance Considerations

Given the January 1, 2027, effective date, businesses should act quickly to:

• evaluate whether their software offerings constitute taxable "digital products" or fall within statutory exclusions
• review customer agreements for tax pass-through provisions
• configure billing systems to collect California sales and use tax based on customer addresses
• establish exemption certificate procedures
• monitor the CDTFA for emergency regulations and guidance

Enterprises with multistate licenses will also need to pay careful attention to sourcing rules and exemption certificate procedures. Additionally, early-stage technology companies that previously deferred sales tax compliance while operating below revenue thresholds or outside traditional taxable product categories may now need to implement compliance infrastructure sooner than historically required.

For more information or questions, please contact the authors or a member of Holland & Knight's State and Local Tax Team.

Information contained in this alert is for the general education and knowledge of our readers. It is not designed to be, and should not be used as, the sole source of information when analyzing and resolving a legal problem, and it should not be substituted for legal advice, which relies on a specific factual analysis. Moreover, the laws of each jurisdiction are different and are constantly changing. This information is not intended to create, and receipt of it does not constitute, an attorney-client relationship. If you have specific questions regarding a particular fact situation, we urge you to consult the authors of this publication, your Holland & Knight representative or other competent legal counsel.