Why this matters
California is the largest economy in the United States and one of the last major states to exempt SaaS from sales tax. For years, software companies selling into California have benefited from that exemption, but SB 122 changes that.
Starting January 1, 2027, California's full state and local sales tax (7.25% state rate, plus local district taxes that vary by buyer location) would apply to prewritten software delivered electronically and SaaS accessed remotely. For most software companies selling into California, sales will become taxable.
This marks a fundamental shift in how California treats software revenue.
What's taxable and what isn't
SB 122 is actually narrower than many states' digital tax regimes. It specifically targets prewritten software in all its modern forms, while leaving a meaningful set of categories untouched.
Newly taxable starting January 1, 2027:
- Prewritten (canned) software, however delivered
- SaaS and remotely accessed software
- Electronically downloaded software
- AI tools (treated as prewritten software, consistent with how every other state that taxes software approaches it)
Still exempt:
- Custom software (built specifically for a single customer)
- Infrastructure as a service (IaaS)
- Digital books and newsletters
- Cryptocurrency and digital assets
- Digital audiovisual, audio, and visual works
- Video games
The key dividing line is "prewritten" versus "custom." If you sell the same software to many customers, it's almost certainly prewritten and taxable. If your software was built from scratch for one client, it's custom and stays exempt. Modifications to prewritten software are a gray area: the modification itself may qualify as custom, but the underlying prewritten product remains taxable.
Who's affected
To trigger a California collection obligation, you need two things.
First, your product must qualify. Sell prewritten software or SaaS, and you're in scope. Second, you need California nexus:
- Economic nexus: more than $500,000 in gross sales to California customers in the current or prior calendar year. Notably, your newly taxable software sales count toward this threshold.
- Physical nexus: California employees, an office, or property in the state.
No California office? That doesn't get you off the hook. Economic nexus is about your sales, not your address. Many software companies that have never registered in California will now have an obligation to do so.
One notable wrinkle for enterprise sellers: California includes a $5 million self-remittance rule. If a single buyer purchases more than $5 million of software from you in a year, that buyer self-remits the tax directly to the state, which relieves you of collecting on that relationship. This is unusual; no other state currently uses this mechanism.
B2B buyers: Most SaaS is sold business-to-business, and some of those buyers won't owe tax, specifically resale buyers and qualifying exempt entities. But you can only skip charging them if you have a valid California exemption or resale certificate on file. Without one, you're required to charge them. Start identifying those customers and collecting certificates well before January 1.
How to prepare before the deadline
Six months sounds like plenty of time. But for teams with manual sales tax processes or clunky sales tax software, it might not be. Registration, billing system changes, and product classification all take lead time, and California registration volume is expected to spike significantly as the deadline approaches. What normally takes a couple of weeks could take much longer if you wait until fall.
Treat this as a year-end project and start now.
1. Confirm your nexus
Map your California sales and determine whether you cross the $500,000 economic nexus threshold. If you're close or already over, you'll need to register with the California Department of Tax and Fee Administration (CDTFA). Registrations can be submitted up to 90 days before the effective date.
2. Classify your products
Review your product catalog against the prewritten-versus-custom line. If you offer bundled products or have configurable platforms, those require closer analysis. The answer affects whether you collect tax at all.
3. Update your billing and tax systems
California's rate isn't uniform. It's 7.25% state plus local district taxes sourced to the buyer's California location. Your system needs to know where each customer is, calculate the right combined rate, and add it to their invoice automatically from day one.
4. Handle exemption certificates
Identify your California B2B customers who may qualify for exemptions. Collect valid California exemption or resale certificates before January 1. Without certificates on file, you're required to charge tax regardless of the buyer's status.
5. Review contracts that straddle January 1, 2027
Annual contracts signed before the effective date but running past it are a gray area. Understand your exposure and consider how to handle new tax obligations for mid-contract customers.
6. Brief your customers
Buyers will see a new tax line item on their invoices starting January 1. Getting ahead of that conversation, especially with large customers, prevents confusion and protects the relationship.
Frequently asked questions
Do all my California sales suddenly become taxable?
No. First, your product must be prewritten software or SaaS (not custom software, not IaaS). Second, you need California nexus: $500,000 in California sales or a physical presence. Below the threshold with no physical presence, you have no California collection obligation.
Is my product "prewritten" or "custom"?
Prewritten means sold the same way to many customers, which describes most SaaS. Custom means built for one specific client and stays exempt. Modifications to prewritten software are exempt only for the custom portion; the underlying product remains taxable. Configurable platforms and professional-services bundles are edge cases worth reviewing carefully.
What rate applies?
California's combined rate at the buyer's location: 7.25% state base rate plus local district taxes, sourced to the buyer's California address (billing address first, then shipping, then payment instrument address).
What's the $5 million rule?
A buyer purchasing more than $5 million of software per year from a single seller remits the tax directly to CDTFA instead of paying it to the seller. This primarily affects large enterprise buyers and the vendors selling to them at scale.
What about my exempt and resale customers?
Some B2B customers, including resale buyers and qualifying exempt entities, won't owe California tax. But you can only skip charging them if you have a valid California exemption or resale certificate on file. Without one, you must charge them. Identify those customers and collect certificates before January 1.
We don't have a California office. Are we still in scope?
Potentially, yes. Economic nexus is triggered by sales volume ($500,000 in California sales), not physical presence. No office doesn't mean no obligation.
What about annual contracts that straddle January 1, 2027?
This is an open gray area. The law doesn't provide clear guidance on contracts signed before the effective date that run past it. Review your existing contracts and consider working with a tax advisor on the right approach for your situation.
What if I bundle software with services?
Bundling creates classification complexity. If the taxable software component can be separated and priced, that portion is taxable. Fully bundled transactions where software and nontaxable services are sold for a single price require closer analysis. This is exactly the kind of question worth bringing to a tax expert before January 1.
The bottom line
California taxing SaaS is the biggest US software tax change in years. The state's sheer size means that for most software companies, this isn't a small compliance line item but a new obligation on revenue that has always been tax-free.
The companies that come out ahead will be the ones that don't treat this as a December problem. Six months is enough time to get registered, get your billing right, and get your customers ready—but only if you start now.
For Anrok customers, our platform was automatically updated. If you have questions about how California's new rules apply to your business, our tax team is here to help.
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