California businesses are preparing for a significant change in how software and cloud-based subscriptions are taxed. Beginning January 1, 2027, California will expand its sales and use tax to include many software products that historically were not subject to sales tax when delivered electronically or accessed over the internet.
This change comes from Senate Bill 122 (SB 122), signed into law on June 29, 2026, as Chapter 23 of the Statutes of 2026.
For businesses that depend on Microsoft 365, Adobe, cybersecurity platforms, accounting software, customer relationship management systems, and other subscription-based applications, the new law could mean additional costs starting in 2027.
At SR Technologies, we want our clients and fellow California business owners to understand what is changing, which products may be affected, what exemptions exist, and how to prepare.
Why Is California Changing Its Sales Tax Rules?
For decades, California’s sales tax treatment of computer software largely depended on how that software was delivered.
Traditionally, prewritten software distributed on physical media, such as CDs, DVDs, or USB drives, was generally taxable. However, the same software delivered electronically, downloaded from the internet, or accessed remotely through a web browser could often be provided without California sales tax.
As technology evolved, businesses increasingly moved away from purchasing software on physical media and toward subscription-based cloud applications.
This created a distinction between traditional software purchases and their modern cloud-based equivalents.
SB 122 is intended to eliminate much of that distinction by expanding taxable property to include qualifying digital software, regardless of whether it is delivered physically, electronically, or accessed remotely.
What the law actually changes
Section 9 of SB 122 amends California Revenue and Taxation Code §6016, expanding the definition of tangible personal property to include:
“A digital product and any copyright or patent interests associated therewith.”
Section 10 adds Revenue and Taxation Code §6016.1, defining a digital product as:
“Prewritten computer software transferred on tangible storage media, transferred electronically, or accessed remotely.”
These changes are important because California’s sales and use taxes generally apply to taxable transactions involving tangible personal property.
By bringing qualifying software into that definition, California establishes a legal basis for taxing many products that previously escaped taxation because they were delivered entirely online.
Effective date: January 1, 2027.
The law applies broadly to qualifying software purchased by both businesses and consumers.
Source: SB 122, Sections 2, 9, 10, and 11; Revenue and Taxation Code §§6006, 6016, 6016.1, and 6016.2.
What Software and Subscriptions Will Be Taxable?
The new law primarily targets prewritten computer software, often described as commercially available or off-the-shelf software.
Importantly, this includes software accessed remotely rather than installed on a computer.
Section 11 defines remotely accessed software as prewritten software residing on a vendor’s or third party’s server and accessed using a password, digital code, or similar method in exchange for payment.
This effectively brings many Software-as-a-Service (SaaS) offerings within California’s sales tax system.
Examples of software potentially affected
| Software category | Common examples |
|---|---|
| Productivity and collaboration | Microsoft 365, Google Workspace |
| Creative and document software | Adobe Creative Cloud, Acrobat |
| Accounting and financial software | QuickBooks Online and similar platforms |
| Business management applications | CRM, ERP, and project management systems |
| Cybersecurity applications | Endpoint protection, email security, and cloud-based security software |
| Backup and data protection software | Cloud backup management applications and backup software subscriptions |
| IT management applications | Remote monitoring, device management, and helpdesk software |
| Industry-specific applications | Commercially available medical, legal, manufacturing, and accounting applications |
These examples illustrate the types of products potentially covered by the law. They are not official product-by-product tax determinations.
Some subscriptions bundle taxable software with other services, requiring additional analysis.
The important distinction is that a product no longer needs to be physically installed or delivered on tangible media to qualify for sales tax.
For example, a company subscribing to Microsoft 365 may owe California sales tax on qualifying software subscription charges even though employees access the applications through the internet.
Similarly, a business purchasing a downloadable license for commercial software may no longer receive different tax treatment simply because the software is delivered electronically instead of on a physical device.
Are All Online Services and Subscriptions Taxable?
No. SB 122 does not impose sales tax on every digital product, subscription, or online service.
This is an important distinction for businesses reviewing their technology budgets.
The legislation specifically excludes several categories of digital products and preserves certain exemptions.
Digital products specifically excluded
Revenue and Taxation Code §6016.1(b) excludes the following from the statutory definition of a digital product:
- Digital books, including qualifying e-books.
- Digital audio works, such as electronically delivered music.
- Digital audiovisual works, such as streamed movies.
- Digital visual works.
- Digital video game products.
- Digital assets, including qualifying blockchain-based assets.
- Digital infrastructure, subject to the statutory definition.
These exclusions mean the new software tax is not equivalent to a general sales tax on all digital content.
Custom-developed software
California also preserves an important exclusion for qualifying custom computer software.
Under Revenue and Taxation Code §6010.9, custom software generally means software developed to the special order of an individual customer rather than software intended for general or repeated sale.
For example, a business hiring a developer to create a unique application specifically for its operations may receive different tax treatment than a business licensing an existing commercial application.
However, customization does not automatically make an entire software product exempt.
If a business purchases a commercially available application and pays separately for custom modifications, only the qualifying custom development portion may receive the exclusion.
The original prewritten software may remain taxable.
Services performed primarily through human effort
Section 17 of SB 122 adds Revenue and Taxation Code §6372.1.
This provision creates an exemption for certain electronically delivered services where:
- The service primarily involves human effort by the provider.
- That human effort occurs after the customer requests the service.
This distinction may be especially important for consulting, technical support, professional services, and managed IT providers.
However, the law specifically prevents this exemption from being used to exclude otherwise taxable access to a provider’s software merely because the software is delivered as part of a service.
Businesses offering combined software and professional services will need to evaluate their products, contracts, and billing structures carefully.
What About Cloud Hosting and Infrastructure?
One of the more significant exceptions involves cloud infrastructure.
Many businesses use cloud platforms to host their own applications, store information, operate virtual servers, and manage business systems.
SB 122 distinguishes certain infrastructure services from taxable prewritten software.
Revenue and Taxation Code §6016.1(c)(8) defines digital infrastructure as a cloud-based service that enables customers to create, deploy, scale, or run their own software without operating the underlying infrastructure.
This distinction is particularly relevant to services commonly classified as:
Infrastructure-as-a-Service (IaaS): Cloud infrastructure used to operate virtual machines, storage systems, networks, and customer-managed applications.
Platform-as-a-Service (PaaS): Cloud platforms that allow businesses to develop, deploy, and operate their own applications.
Qualifying infrastructure services are excluded from the new statutory definition of a digital product.
However, the distinction between infrastructure and software subscriptions is not always straightforward.
For instance, a hosted virtual server may qualify as digital infrastructure, while a separate commercially available software license running on that server may be taxable.
Bundled offerings containing both infrastructure and software may require additional review.
Businesses should not assume that every cloud service is taxable, or that every service described as cloud hosting is exempt.
How Will Sales Tax Be Calculated?
California sales tax rates vary by location because the total applicable rate can include state, local, and district taxes.
SB 122 establishes specific rules for determining where electronically delivered software transactions occur.
Under Revenue and Taxation Code §6010.5, electronically delivered software purchased outside an in-person retail transaction is generally sourced using the purchaser’s known California address in the seller’s ordinary business records.
When multiple addresses are provided during the transaction, the law establishes an order of priority:
- The purchaser’s billing address.
- The purchaser’s shipping or delivery address.
- The mailing address associated with the payment method.
- The purchaser’s mailing address.
If an address was not supplied during the transaction, the law provides a similar hierarchy using previously supplied information.
This means the address associated with your organization’s software subscriptions and billing accounts may affect which local tax rate applies.
Example: A business with $2,000 in monthly software subscriptions
Consider a California business spending $2,000 per month on qualifying taxable software subscriptions.
Using an illustrative combined sales tax rate of 9%, the financial impact would be:
| Expense | Monthly | Annual |
|---|---|---|
| Software subscriptions | $2,000 | $24,000 |
| Additional sales tax (9%) | $180 | $2,160 |
| New total | $2,180 | $26,160 |
In this example, the business would incur an additional $2,160 annually without any change in the underlying software subscription prices.
This is an illustration, not a statement of the tax rate applicable to a particular business. Actual charges depend on the applicable rate, product classifications, exemptions, and other tax rules.
For organizations with dozens or hundreds of users, the additional expense could be more substantial.
What Happens If Employees Work Outside California?
Businesses with employees in multiple states face additional considerations.
A company headquartered in California may purchase software subscriptions used by employees in Oregon, Nevada, Texas, Florida, or other states.
SB 122 provides an exemption for qualifying digital products purchased solely for use outside California or in interstate or foreign commerce.
Revenue and Taxation Code §6372 establishes this exemption and allows qualifying purchasers to provide exemption certificates.
The legislation also gives the California Department of Tax and Fee Administration (CDTFA) authority to establish alternative methods for fairly determining tax when software licenses are available for use in multiple locations.
These provisions are especially relevant to organizations with remote employees, multiple offices, or nationwide operations.
However, having employees outside California does not automatically make the entire subscription exempt.
Businesses should maintain accurate user locations, subscription records, and supporting documentation. Multi-state allocations should follow applicable regulations and guidance.
Will Managed IT Services Be Taxable?
This is an especially important question for businesses receiving managed IT services, technical support, and cybersecurity subscriptions.
The answer depends on what is being provided.
Managed IT agreements often combine several different types of services and products, including technical support, monitoring, security software, backup applications, cloud services, and professional labor.
SB 122 does not automatically make every element of a managed IT agreement taxable.
However, qualifying prewritten software delivered as part of an agreement may be subject to the new tax.
For example, an agreement might contain:
| Service or product | Potential treatment under SB 122 |
|---|---|
| Remote helpdesk assistance | Human-delivered service; may qualify for exclusion |
| On-site technical support | Generally outside this new software-tax expansion |
| IT consulting and professional labor | Generally outside this new software-tax expansion |
| Microsoft 365 subscriptions | Potentially taxable prewritten software |
| Endpoint security software licensing | Potentially taxable |
| Cloud backup software subscriptions | Potentially taxable software component |
| Cloud infrastructure hosting | Potentially excluded digital infrastructure |
| Custom software development | Qualifying custom work may be excluded |
The treatment of an individual charge depends on the specific agreement, what the customer receives, and how the transaction is structured.
Businesses should also understand that separately identifying services on an invoice does not, by itself, guarantee favorable tax treatment. Bundled transactions may require further analysis.
At SR Technologies, we are reviewing our recurring service and subscription classifications to determine which charges are subject to the new requirements.
Our objective is to collect applicable taxes where required without applying the new software tax indiscriminately to services that do not fall within its scope.
What About Existing Annual Software Subscriptions?
Many businesses pay monthly for their software subscriptions, while others commit to annual agreements or pay for multiple years in advance.
The law’s operative date is January 1, 2027.
However, the tax treatment of subscriptions purchased before that date, renewal transactions, advance payments, and contracts covering periods before and after January 1, 2027 may depend on the transaction structure and implementing regulations.
Businesses should not assume that every existing subscription automatically becomes taxable on January 1 regardless of when it was purchased or invoiced.
Likewise, businesses should not assume that every pre-2027 agreement is permanently exempt.
California’s tax authorities are developing regulations and guidance to clarify implementation details.
Organizations with substantial prepaid or multi-year software agreements should consult their accounting or tax advisers before restructuring or accelerating purchases for tax reasons.
Does the Law Affect Large Enterprise Software Purchases?
Yes, although a special provision applies to certain high-volume transactions.
Sections 12 and 14 of SB 122 establish a threshold involving more than $5 million in aggregate purchases of electronically delivered or remotely accessed digital products from a retailer by a purchaser.
Under the specified conditions, the purchaser rather than the retailer becomes responsible for self-assessing and paying use tax directly to California.
Beginning in 2028, the threshold test considers the current or preceding calendar year.
The law includes requirements for direct-payment permits and allows the CDTFA to establish certain administrative exceptions.
For most small and midsize businesses, this provision will not be relevant.
Importantly, this is not a $5 million tax-free allowance. It is a mechanism affecting responsibility for collecting and remitting the applicable tax.
Who Is Responsible for Collecting the Tax?
Typically, retailers selling taxable software are responsible for collecting applicable sales tax reimbursement or use tax from customers, subject to the applicable legal requirements.
Software vendors and resellers must evaluate their California tax obligations, including whether they are required to register, collect tax, and remit it to the state.
In some circumstances, purchasers may be responsible for paying use tax directly.
For businesses purchasing software through an IT provider, software reseller, or other intermediary, the tax treatment may depend on the nature of the transaction and the reseller’s relationship with the software publisher.
The new law does not mean that a customer should pay sales tax twice on the same taxable transaction.
However, businesses should review their invoices and retain documentation showing applicable taxes paid.
How Should California Businesses Prepare?
With the effective date approaching, we recommend several practical steps.
1. Review your software subscriptions
Identify recurring software expenses, including cloud applications, software licensing, backup systems, cybersecurity applications, and other services delivered electronically.
2. Update your 2027 technology budget
Account for potential sales tax on qualifying software subscriptions.
Even without subscription price increases, organizations may experience higher total technology expenses.
3. Verify billing information
Make sure software vendors and service providers have the correct business billing address and relevant location information.
4. Identify exempt or potentially excluded services
Review custom-developed software, digital infrastructure, professional services, and subscriptions used outside California.
5. Review invoices beginning in January
Confirm that taxes are being applied where appropriate and investigate unexpected charges or changes.
6. Consult your tax professional
Businesses with complex subscription agreements, multiple locations, resale arrangements, or large software expenditures should obtain professional guidance.
What SR Technologies Clients Can Expect
SR Technologies is preparing for the implementation of SB 122 and reviewing our recurring billing processes ahead of January 1, 2027.
As part of this process, we are evaluating the appropriate tax treatment of software licenses, cybersecurity subscriptions, cloud-based applications, and other recurring technology products.
Starting in 2027, clients may notice applicable California sales tax added to qualifying software and subscription charges.
These additional charges are the result of changes in California tax law, not an increase in SR Technologies’ underlying service pricing.
We will continue working to ensure our billing practices reflect applicable requirements and that clients receive clear, understandable invoices.
We also encourage clients preparing their 2027 budgets to account for the potential increase in software subscription costs.
Frequently Asked Questions
Is California really going to tax Microsoft 365 subscriptions?
Microsoft 365 contains commercially available software and cloud-based applications of the type addressed by SB 122. Qualifying subscription charges are expected to fall within the expanded sales tax requirements beginning January 1, 2027, subject to applicable product classifications and exemptions.
Will my existing subscription price increase?
Your software vendor’s underlying subscription price may remain unchanged. However, adding applicable sales tax can increase the total amount you pay.
Does the law apply to businesses or only consumers?
Both. SB 122 generally expands the taxation of qualifying software transactions without limiting the change to consumer purchases.
Will I pay sales tax on IT labor and technical support?
Not automatically. The new provisions primarily target qualifying prewritten software. Human-delivered services may receive different tax treatment, although bundled arrangements require review.
Is cloud hosting taxable?
Qualifying digital infrastructure is excluded under the statutory definition. However, separately licensed software and some bundled cloud offerings may be taxable.
Will every online subscription be taxed?
No. The legislation includes specific exclusions and exemptions. The nature of the product or service matters.
How much additional sales tax will I pay?
The amount depends on the taxable portion of your subscriptions and the applicable state, local, and district tax rates.
When does the change take effect?
The software sales and use tax provisions of SB 122 become operative January 1, 2027.
Final Thoughts
California’s expansion of sales and use tax to electronically delivered software represents a major change for businesses that rely on cloud computing and subscription-based technology.
While the law is intended to modernize how software is taxed, it also introduces new budgeting considerations and compliance requirements.
For small and midsize organizations, the most immediate impact will likely be higher total spending on qualifying software subscriptions.
Understanding the distinction between taxable software, excluded infrastructure, custom development, and professional services is essential to preparing for the change.
At SR Technologies, our goal is to help businesses make informed technology decisions, plan for upcoming expenses, and avoid surprises.
Have questions about how these changes may affect your technology expenses?
Contact SR Technologies at (707) 238-5519 or visit srtech.com.
Sources and Further Reading
1. California Senate Bill 122 — Chapter 23, Statutes of 2026
View SB 122 through CalMatters Digital Democracy
Relevant provisions include:
- Revenue and Taxation Code §6006 — Definition of sale
- §6010 — Definition of purchase
- §6010.5 — Location and sourcing of transactions
- §6010.5.1 — Place of use of digital products
- §6010.9 — Custom computer software
- §6016 — Tangible personal property
- §6016.1 — Definition and exclusions for digital products
- §6016.2 — Remote access and electronic transfer
- §§6052 and 6201.55 — Large digital-product purchases
- §6372 — Out-of-state and interstate-use exemption
- §6372.1 — Qualifying human-effort services exemption
2. Avalara — California to Tax Software and SaaS in 2027
Read Avalara’s analysis
Provides additional explanation of the statutory changes, sourcing rules, exclusions, and developing implementation guidance.
3. KPMG — California Governor Signs Bill to Expand Taxation of Prewritten Software
Read KPMG’s tax analysis
Disclaimer: This article is provided for general informational purposes only and does not constitute legal, accounting, or tax advice. Taxability may depend on the products purchased, contractual arrangements, applicable exemptions, and guidance issued by the California Department of Tax and Fee Administration. Businesses should consult a qualified tax professional regarding their specific circumstances.
Last reviewed: October 14, 2026.
