California 7.5% sales tax on SaaS & software January 2027

1 January 2027 $2 billion digital sales tax reform on software-as-a-services

California has approved one of the most significant US indirect tax changes in recent years by extending sales and use tax to prewritten software and Software-as-a-Service (SaaS). Signed into law by Governor Gavin Newsom under Senate Bill 122, the new rules take effect on 1 January 2027, marking a major expansion of the state’s sales tax base and subjecting it to the state-level sales tax of 7.5%.

It is joining Texas, New York, Washington and Pennsylvania which already levy sales tax on many SaaS transactions.

Removing the sales tax exemption

Until now, California generally exempted digitally delivered software and SaaS from sales tax. The reform modernises the tax rules to reflect the growing digital economy and is expected to raise almost $2 billion annually for state and local governments.

Under the new rules, prewritten software will be taxable regardless of whether it is supplied via physical media, electronic download or remote cloud access. Fully customised software developed for a single customer remains exempt, as do separately identified charges for custom modifications.

Importantly, California has not introduced a broad digital services tax. Many digital products remain outside the scope, including:

• Digital books
• Music and streamed audiovisual content
• Video games
• Cryptocurrency and other digital assets
• Cloud infrastructure services (IaaS)

Determining sourcing rules; no multi-state allocation

The legislation also introduces detailed sourcing rules. Remote sales will generally be taxed based on the customer’s California address, following a hierarchy of billing, shipping, payment instrument and mailing addresses. Unlike several other US states, California has not adopted a multi-state allocation framework, meaning businesses cannot apportion SaaS subscriptions between California and out-of-state users under the legislation.

A further compliance change applies to large transactions. Where annual receipts from qualifying digital product sales exceed $5 million, responsibility for paying the tax can shift from the seller to the purchaser, who must self-assess California use tax.

The legislation leaves several questions for future guidance from the California tax authorities, particularly around the treatment of Platform-as-a-Service (PaaS) and other evolving cloud services.

How California compares with other states

California joins a growing number of US states that have expanded sales tax to software and cloud services, although approaches remain far from uniform. States including Texas, New York, Washington and Pennsylvania already tax many SaaS transactions, while others continue to exempt them or apply industry-specific rules.

California’s legislation is notable for its clear statutory definition of taxable digital software, but unlike Texas and New York, it does not currently provide a mechanism for allocating multi-state SaaS subscriptions based on where the software is actually used.

US Sales Tax rates and selling thresholds