California SB 122: What It Means for Companies

By Tony Caldwell, Geoffrey L. Gunnerson, Priscilla Ayn Parrett, Nida Salim Rais, and Monique Torres

California recently enacted SB 122, which represents a significant expansion of the state’s sales and use tax framework as it applies to digital products, including prewritten computer software delivered electronically and software accessed remotely, including most SaaS and cloud-based arrangements. Under the existing California sales and use tax framework, sales and use tax has generally applied to transactions involving tangible personal property. Persons engaged in the business of rendering services have historically been treated as consumers, not sellers, of tangible personal property used incidentally in rendering those services, and sales and use tax applied to the purchase of such tangible property by such service providers. Because California did not historically include  electronically delivered software or SaaS in the definition of digital goods, effective January 1, 2027, the enactment of SB 122 marks a significant development for any company that sells into or buys from California, with meaningful downstream effects across sectors.

By bringing prewritten computer software delivered electronically and software accessed remotely (e.g., SaaS) within the scope of California’s sales and use tax framework, SB 122 closes a longstanding gap between the tax treatment of software delivered on tangible media and software delivered by electronic or cloud-based means. The legal consequences include the creation of new definitions, new compliance obligations for retailers and purchasers, a retailer-relief mechanism for large-volume digital transactions, and an anti-rebate provision. It is expected that the economic consequences will include increased costs for software consumers (given that California is home to a significant portion of the nation’s technology industry), new administrative burdens for SaaS providers, and effects on California’s competitive position relative to states that do not tax these transactions.

Planning Ahead for SB 122 Compliance

Two mechanics deserve particular attention as companies plan ahead for SB 122 compliance. First, sales are generally sourced to California based on the purchaser’s known address, determined by a fixed hierarchy (billing address, then shipping/delivery address, then payment-instrument address, then mailing address), with a safe harbor where the purchaser certifies the software is for use outside California or in interstate or foreign commerce. This may be a change for companies that generally source sales based on shipping location, which is a common method for other kinds of transactions. Second, sellers bear collection and remittance obligations by default, but sellers are relieved of this obligation under certain circumstances. In this context, SB 122 includes a unique seller-relief mechanism tied to revenue thresholds. Notwithstanding the general rule in Section 6010.5 of the California Revenue and Tax Code, a seller is relieved from liability to collect and pay sales tax on the sale of a digital product that is transferred electronically or accessed remotely if the gross receipts from the sale of digital products (including SaaS) by that seller to a single purchaser exceed $5 million in the aggregate in the current calendar year, or, beginning January 1, 2028, in the current or the preceding calendar year.  When the seller exceeds this threshold with a given purchaser, the purchaser becomes liable for the use tax on the transaction that caused the seller to exceed the threshold and on any adjustments made thereafter. This seller-relief provision creates compliance complexity for both the seller and the purchasers of digital products.

The California Department of Tax and Fee Administration (CDTFA), the department charged with implementing sales and use taxes in California, held their first “listening session” to discuss the new law on July 21, 2026. During that meeting, several themes emerged including discussions regarding how these sales would be sourced, how multi-year contracts would be treated, who will bear collection responsibility, and the timing of regulations.

As companies begin to plan ahead for the change, there are a number of important things to consider. For example, companies that bundle software with data, support, implementation, or other services will need to revisit how those offerings are structured, described, and invoiced, since classification will drive taxability. Enterprise-wide licenses used across multiple locations raise their own sourcing and administration questions that billing and contracting teams should get ahead of now. Also, companies approaching or exceeding the $5 million purchaser threshold should confirm their tax reporting and procurement processes can  support a purchaser-side use tax remittance obligation, because that is a new function for many purchasers. Given the operative date of January 1, 2027, for the new sale and use tax rules on digital products, companies have a limited transition period to review their software and SaaS procurement arrangements and agreements, update billing and tax collection systems, and evaluate the impact of the new tax on their cost structures.

These considerations will be especially important for any upcoming M&A deal. In any deal touching California, purchasers should expect and sellers should prepare for closer scrutiny of a target’s software and SaaS classification, sales and use tax licensing, tax collection procedures, and any exposure from under-collected sales or use tax, with the purchaser-remittance rule adding a new diligence item for large purchasers of digital products. Companies with significant California software revenue or spend should have these matters assessed well before any transaction process begins.

Bottom line: Companies doing business with California have a limited but meaningful runway to prepare for SB 122 compliance. Companies transacting in California should focus on (1) classifying their software and bundled offerings and contracts now, (2) confirming their billing and contracting systems can capture and apply the sourcing hierarchy, (3) modeling exposure against the $5 million threshold, and (4) flagging this issue early in any pending or upcoming M&A process, since it will increasingly shape diligence and deal terms.