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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)
UPDATE: CDTFA Released Proposed Regulations Ahead of 2027 Implementation. California is providing additional guidance on its upcoming expansion of sales and use tax to software as a service (SaaS). Following the passage of Senate Bill (SB) 122, the California Department of Tax and Fee Administration (CDTFA) released proposed emergency regulations on September 1, 2026, to clarify how the new tax will apply beginning January 1, 2027. As previously reported, the legislation represents a major change to California’s longstanding treatment of electronically delivered software and SaaS. While the new law makes prewritten software taxable regardless of how it is delivered or accessed, the proposed regulations provide additional guidance on several important areas that businesses should consider before the effective date.
One of the most important updates concerns when software transactions become taxable. Under proposed Regulation 1600, the tax generally applies when a customer receives the right to access or use the software, regardless of when the customer pays. For example, software purchased in December 2026 but made available for use beginning January 1, 2027, would be taxable. However, software purchased and made available in December 2026 would remain nontaxable even when payment is received in 2027. The CDTFA also clarified that periodic software subscriptions are considered continuing sales. As a result, subscription periods beginning January 1, 2027, will be taxable, even if the agreement was entered into before that date.
The proposed regulations also provide examples of digital products that fall outside the expanded tax. These include digital books, music, movies, digital artwork, entertainment video games, and qualifying digital infrastructure services. The CDTFA identifies infrastructure as a service (IaaS) and platform as a service (PaaS) as examples of excluded digital infrastructure when the services allow customers to create, deploy, or operate their own software. Custom software also remains exempt, including separately stated charges for qualifying custom modifications. However, businesses should be aware that not all electronically provided services qualify for exemption. The proposed guidance includes an artificial intelligence (AI) related example illustrating that the tax treatment depends on the software being provided, not simply whether the technology produces customized results. Services primarily involving human effort performed after a customer’s request may be exempt, but the exemption does not apply to the right to access or use software provided through a typical SaaS agreement.
Another significant development is the proposed treatment of software used in multiple states. Under proposed Regulation 1600.2, businesses may use a reasonable and consistent method to allocate software charges between California and other states. The CDTFA identifies the number of users or computers located in each state as acceptable allocation methods. However, allocating charges based solely on the location of the servers hosting the software would not be considered reasonable. The proposed regulation also introduced a multiple-points-of-use certificate that purchasers may provide to sellers to document the allocation and support the exclusion of charges attributable to use outside of California. The proposed regulation also addressed software purchased exclusively for use outside of California. Qualifying transactions may be exempt when the applicable requirements are satisfied, and the purchaser provides appropriate documentation.
The proposed regulations further explained the new tax reporting requirements for large digital product purchases. Beginning in 2027, when a retailer’s sales of qualifying digital products to a single purchaser exceed $5 million during the calendar year, the purchaser becomes responsible for reporting and paying use tax directly to the CDTFA, starting with the transaction that exceeds the threshold. Affected purchasers must obtain a use tax direct payment permit. However, CDTFA may grant a waiver allowing the seller to continue collecting and remitting the tax. Beginning in 2028, the threshold determination will consider sales in either the current or preceding calendar year. The proposed requirements create additional administrative responsibilities for both sellers and purchasers. Businesses will need to monitor cumulative sales to individual customers, identify when the threshold is crossed, and coordinate the transition from seller collected tax to purchaser reported use tax.
The CDTFA held an interested parties meeting on September 10, 2026, and accepted written comments through September 24, 2026. Although the proposed regulations provide much-needed clarification, they are not final and may be revised before implementation. The CDTFA has also indicated that additional guidance may be necessary to address questions not covered by the initial regulations. With the January 1, 2027, effective date approaching, businesses should continue reviewing their software products, existing contracts, subscription billing practices, and multi-state documentation. Sellers and purchasers should also evaluate whether the new direct payment permit requirements may apply to their transactions. The proposed regulations are a key step toward implementing SB 122, but businesses should continue monitoring developments as California finalizes its approach to taxing software and SaaS.
(Discussion Paper: Application of Sales and Use Tax to Digital Products, California Department of Tax and Fee Administration, September 1, 2026.)