With the passage of SB 122, California’s definition of “tangible personal property” (TPP) has expanded to include certain digital products, specifically prewritten (canned) computer software, regardless of how it is delivered. Historically, California limited sales tax to items that could be physically seen or touched, which generally excluded electronically delivered software and cloud-based access. Under this bill, that distinction is no longer. Beginning January 1, 2027, prewritten software is treated as taxable TPP whether delivered on physical media, downloaded, or accessed remotely via the cloud.
The law explicitly states that a taxable transaction includes any transfer of rights to “access, use, download, or manipulate” a digital product. This language captures most modern software delivery methods, including enterprise SaaS platforms, subscription-based tools, and hosted applications. However, the bill maintains exclusions for custom software and certain categories of digital content, such as digital books, music, video, and games. It also carves out exceptions for transactions that primarily involve human effort after the customer request, preserving the service distinction in areas like consulting or data processing services.
In addition to expanding the tax base, SB 122 introduces detailed sourcing rules critical to determining where a digital sale is taxed. Because digital products are not tied to a physical location, the bill adopts a customer-based sourcing methodology. For remote or electronically delivered products, the sale is sourced to the purchaser’s “known address” in California, with the law establishing a clear hierarchy to determine that address:
This hierarchy places great importance on how sellers collect and maintain customer data, as that information directly determines taxability and applicable local rates. For in-person sales of digital products, sourcing remains tied to the seller’s place of business, although these transactions are expected to be less common. If no reliable address information is available, the sale may be treated as occurring outside California, but only if the seller can demonstrate a reasonable effort to obtain accurate data, creating a documentation standard that will likely become an audit focus for businesses with high volumes of remote transactions.
The bill also introduces a concept of “place of use” for digital products, which applies primarily to use tax. This is defined as the location where the purchaser actually uses or accesses the software. For remote access, that is, where the user is physically located when using the product. This creates potential complexity for businesses with multi-state operations or distributed workforces, as a single software license could have users in multiple jurisdictions. The law anticipates this and allows the tax authority to approve reasonable allocation methods to fairly reflect in-state use.
Another major operational change tied to both taxability and sourcing is the introduction of a $5 million threshold for digital product purchases. When a purchaser exceeds this threshold, the obligation to report and pay tax can shift from the seller to the buyer. In these cases, the buyer must self-assess the use tax and often obtain a direct payment permit. This effectively moves large enterprise buyers into a self-compliance model and relieves some of the collection burden on sellers, yet it also adds complexity to transaction tracking, exemption certificate management, and audit risk on both sides.
Taken together, the updated definition of TPP and the new sourcing rules represent a combined effort to modernize California’s sales tax system for the digital economy. For businesses, this means greater emphasis on product classification, customer data quality, and internal systems that track where and how digital products are used. From a compliance perspective, these changes will likely increase audit exposure in the short term as both taxpayers and regulators adjust to the new rules, particularly in industries where the distinction between software and services has historically been blurred.
This expanded definition has a direct and significant impact on the digital industry. Companies that previously relied on the position that remote access to software was a non-taxable service will need to reassess their taxability.
As a result, the compliance challenge shifts from format-based analysis to classification analysis, where businesses must clearly determine whether they are selling software, a service, or a hybrid of both. This approach places a significant burden on sellers to collect and maintain accurate customer location data, as that information drives both taxability and rate determination. (Cal. S.B. 122, 2025–2026 Reg. Sess., ch. 23 (Cal. 2026) (effective Jan. 1, 2027)