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California organizations that depend on cloud software, online subscriptions, and digital business platforms should begin reviewing their technology spending before the end of 2026.
On June 29, 2026, Governor Gavin Newsom signed Senate Bill 122, part of the 2026-27 budget trailer package, into law as Chapter 23 of the Statutes of 2026. The legislation changes California’s sales and use tax treatment of many electronically delivered and remotely accessed software products. The new rules generally apply to transactions occurring on or after January 1, 2027.
The change will affect more than traditional technology companies. Businesses, universities, nonprofits, foundations, professional firms, healthcare organizations, and community institutions may all need to evaluate how taxable software costs could affect budgets, renewals, procurement processes, and internal reporting.
This article is general educational information, not tax, legal, or accounting advice. Organizations should consult qualified professionals regarding their specific contracts and obligations.
What changes on January 1, 2027?
California law has historically treated many prewritten software products delivered electronically or accessed remotely differently from software transferred on physical storage media. SB 122 expands the definition of taxable tangible personal property to include a “digital product.”
As explained in EY’s summary of California SB 122 and Grant Thornton’s analysis, a digital product generally includes prewritten computer software that is:
- Transferred on tangible storage media
- Downloaded or transferred electronically
- Accessed remotely through a vendor’s or third party’s server
The practical result is that many common software arrangements may become subject to California sales or use tax, regardless of whether the organization receives a physical product.
Potentially affected arrangements include:
- Software-as-a-Service subscriptions
- Remote access to prewritten software
- Software licenses
- Software leases
- Electronically downloaded applications
- Subscription-based business platforms
- Enterprise software access agreements
The categories may include customer relationship management systems, accounting platforms, productivity suites, communication tools, design applications, human resources systems, project management platforms, cybersecurity products, artificial intelligence subscriptions, data and analytics tools, and other standardized business applications.
Products similar to Microsoft 365, Salesforce, Adobe Creative Cloud, QuickBooks Online, and Slack may fall within the general scope of the new rules. These names are illustrative only. Final treatment will depend on the specific product, contract, billing structure, use of the software, and applicable regulations or guidance.
Who may be affected?
SB 122 does not create a general exemption simply because the purchaser is a business, nonprofit, university, foundation, or government agency.
That distinction matters. Organizations often view software as an operating input rather than a consumer purchase. Under the new framework, the fact that software supports a charitable program, academic department, public service, or commercial operation does not by itself remove the transaction from potential sales or use tax treatment.
The effect may be modest for a small organization with only a few subscriptions. It can become more significant for institutions with dozens or hundreds of software agreements.
Consider these simplified illustrations using a combined sales tax rate near 10 percent:
- An organization with $100,000 in potentially taxable annual software subscriptions could face approximately $10,000 in additional annual tax expense.
- An organization with $250,000 in potentially taxable software spending could face approximately $25,000 in additional expense.
- An organization with $500,000 in potentially taxable software spending could face approximately $50,000 in additional expense.
These are not forecasts or estimates of any organization’s actual liability. Tax rates vary by location, and not every software contract will be taxable. The illustrations show why a seemingly small percentage applied across a broad technology portfolio deserves a place in budget planning.
For businesses, the additional cost may affect margins, pricing, technology investment, and administrative overhead. For universities and professional firms, it may influence departmental allocations and enterprise procurement decisions. For nonprofits and foundations, the same expense competes with program delivery, staffing, grants, scholarships, and community investment.
What remains excluded?
SB 122 does not make every digital product taxable. The law excludes several categories from the definition of a digital product.
As summarized by Grant Thornton and DLA Piper, exclusions include qualifying:
- Digital books
- Digital audio works
- Digital audiovisual works
- Digital visual works
- Digital video game products
- Digital infrastructure
- Digital assets
Custom computer software also receives different treatment. Software prepared specifically for a single customer generally is not treated as a taxable digital product. Separately stated charges for qualifying modifications to existing prewritten software may also receive different treatment from the underlying prewritten software.
The law also distinguishes certain services primarily involving human effort. A service delivered electronically may remain outside the software tax rules when the principal value comes from human work performed after the customer requests the service. That exclusion does not generally cover the customer’s separate right to use the provider’s prewritten cloud software.
These distinctions make contract structure important. Organizations should review whether an agreement includes:
- Prewritten software access
- Custom development
- Custom modifications
- Implementation services
- Consulting
- Training
- Support or maintenance
- Data processing
- Digital infrastructure
- Other human-effort-centered services
A bundled invoice may not provide enough clarity for an organization to determine how each component should be treated. Contract language and separately stated charges can affect the analysis, but an organization should not restructure an agreement solely to seek a tax result without professional review.
Location and sourcing will matter
SB 122 establishes sourcing rules for electronically delivered and remotely accessed digital products. For transactions that are not conducted in person, the place of sale or purchase generally depends on the purchaser’s known California address maintained in the seller’s records.
The statutory hierarchy generally looks to the purchaser’s:
- Billing address
- Shipping or delivery address
- Address associated with the payment instrument
- Mailing address
The California Department of Tax and Fee Administration’s digital products discussion paper explains that the place of use is generally where a right or power over the digital product is exercised. For remote access, that may be the location where the user is located.
This creates practical questions for organizations with:
- Multiple California offices
- Employees working in several states
- Enterprise licenses assigned to users in different jurisdictions
- Remote or hybrid workforces
- Software used both inside and outside California
- Centralized procurement for decentralized departments
The law provides an exemption for digital products purchased solely for use outside California or in interstate or foreign commerce, subject to documentation requirements. A purchase made outside California may also be presumed to involve California use if the product is used in California within 90 days, depending on the facts.
SB 122 also creates a $5 million threshold affecting who reports and remits tax on certain electronically transferred or remotely accessed digital products. In 2027, the threshold generally looks to a retailer’s aggregate receipts from digital product sales to a purchaser during the current calendar year. Beginning in 2028, the test generally includes the current or preceding calendar year.
Once the threshold is exceeded, the purchaser may become responsible for self-assessing and paying use tax directly to the CDTFA, subject to the law and applicable administrative procedures. CDTFA materials describe proposed guidance concerning direct payment permits, multiple points of use, certificates, and related compliance issues.
Large organizations should not assume that a single enterprise license receives identical treatment for every user. This issue should be reviewed with qualified tax professionals.
Why organizations should review software spending now
Technology budgets are often established well before the fiscal year begins. Annual renewals, multi-year agreements, enterprise expansions, user adjustments, and vendor negotiations may already be underway when the new tax takes effect.
A review before December 31, 2026, gives leadership teams time to:
- Identify recurring software commitments
- Understand which agreements renew before or after January 1
- Estimate potential 2027 exposure
- Evaluate whether contracts contain taxable and nontaxable components
- Review how user locations are documented
- Confirm whether vendor invoices will include sales tax
- Determine whether self-assessment procedures may apply
- Update technology and operating budgets
Organizations may also examine legitimate prepayment or renewal opportunities. However, they should avoid assuming that paying an invoice before year-end automatically eliminates future tax. The tax treatment may depend on when the right to access the software begins, whether the transaction is a continuing subscription, the terms of the agreement, and final CDTFA guidance.
The California Department of Tax and Fee Administration’s rulemaking materials identify proposed or amended regulations involving computers and data processing, technology transfer agreements, custom software, digital products, multiple points of use, out-of-state use, and use tax direct payment permits. Further guidance may refine how specific arrangements are treated.
A practical preparation checklist
Leadership, finance, procurement, information technology, and legal teams can begin with a shared inventory.
Review the following steps:
- Inventory every recurring software subscription and license.
- Include CRM, accounting, finance, payroll, HR, communications, cybersecurity, project management, marketing, data, analytics, and AI platforms.
- Identify products that are likely to qualify as prewritten software or SaaS.
- Separate software access from implementation, consulting, training, and other services where the contract supports that distinction.
- Review custom development agreements and separately stated modification charges.
- Examine annual and multi-year contract renewal dates.
- Model potential 2027 tax costs using location-specific rates.
- Review how licenses are assigned to California and out-of-state users.
- Document software purchased solely for use outside California when an exemption may apply.
- Coordinate with tax advisors, procurement teams, finance departments, information technology leaders, and legal counsel.
- Determine whether any large purchaser self-assessment or direct payment procedures may be relevant.
- Update 2027 budgets before final approval.
- Monitor final CDTFA regulations, forms, certificates, and administrative guidance.
A disciplined inventory may also reveal duplicate tools, unused seats, overlapping functions, or contracts that should be renegotiated for operational reasons. The objective should not be to reduce technology indiscriminately. It should be to understand the organization’s technology portfolio and allocate resources deliberately.
Implications for nonprofits, foundations, and community organizations
For a nonprofit, foundation, university, or community organization, software is connected to mission delivery. A donor database supports fundraising. A finance platform supports accountability. A communications system supports outreach. A cybersecurity platform protects sensitive information. A project management tool helps staff coordinate services.
An added operating cost can therefore reach beyond the technology budget. It may compete with staffing, direct programs, grants, scholarships, community investment, or reserves.
The MFHC Philanthropreneur perspective treats operational discipline and community impact as connected responsibilities. Sustainable growth requires organizations to understand the full cost of the systems that support their work, while protecting the resources that make their missions possible. That principle applies broadly and does not make any representation about MFHC’s own contracts or tax treatment.
Plan before the first taxable invoices arrive
January 1, 2027, is approaching. Organizations that begin now will have more time to review contracts, identify likely exposure, evaluate renewal decisions, coordinate with advisors, and update budgets.
Organizations that wait until the first taxable invoices arrive may face unplanned expenses after annual budgets have already been approved. They may also have to resolve sourcing, documentation, and internal reporting questions under time pressure.
SB 122 represents a significant change in how California treats many electronically delivered and remotely accessed software products. The most practical response is careful preparation based on the actual contract, the actual product, the actual user locations, and the final administrative guidance.
For general business information and additional organizational insights, visit McFadden Finch Holdings Company or contact info@m-fhc.com. MFHC does not provide individualized tax or legal advice through this article or inquiry channel.
Research sources
- California Senate Bill 122, 2025-2026 Regular Session
- EY Tax News: California governor signs budget trailer bill taxing digital software
- Grant Thornton: California enacts software tax rules and extends credit limitations
- Baker Tilly: California software sales tax changes
- BDO: California moves to subject digital prewritten software to sales and use tax
- DLA Piper: California expands sales and use tax to digital products
- California Department of Tax and Fee Administration digital products discussion paper
- California Department of Tax and Fee Administration digital products workshop materials
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