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What does California SB 122 change, and when does it take effect?
Beginning January 1, 2027, California SB 122 expands sales and use tax to many digital products that were previously untaxed when delivered electronically or accessed remotely.
For SaaS startups, the central change is that qualifying prewritten software generally becomes taxable beginning January 1, 2027, whether customers download it or access it through a browser, an application or an API. California will treat qualifying digital products as tangible personal property for sales and use tax purposes.
The law changes the tax treatment of the product, but it does not automatically require every software company to collect tax. A startup must still determine whether its offering is taxable and whether the company has enough connection to California to create a collection obligation.
Which SaaS products are taxable, excluded or exempt?
A conventional SaaS subscription will generally be taxable when the customer is paying to access standardized, prewritten software that is also offered to other customers. Downloaded software and standard software licenses are treated similarly.
The result can be different when the customer is purchasing custom software created for its specific requirements. Separately stated custom modifications may also receive different treatment from the underlying standard product.
Qualifying digital infrastructure is excluded from the definition of a digital product. This can include certain Infrastructure as a Service and Platform as a Service offerings that allow customers to create, deploy or run their own software.
A service delivered electronically may also qualify for an exemption when its primary value comes from human effort performed after the customer requests the service. Calling a product a service is not enough. California looks at what the customer is actually buying.
The rules can apply to both business customers and consumers. A business-to-business sale is not automatically exempt, although resale and other specific exemptions may apply when the seller receives valid documentation.
Do out-of-state and Delaware companies need to collect California sales tax?
Incorporating in Delaware or operating from another state does not, by itself, remove a California sales tax obligation.
An out-of-state SaaS company may still need to collect California tax when it sells a taxable product and has physical or economic nexus with the state.
Physical nexus can arise through employees, offices, property, inventory or other qualifying business activities in California. A startup with California employees may therefore need to evaluate registration even when its California revenue is still relatively limited.
Economic nexus may apply when a retailer has combined sales of tangible personal property delivered into California that exceed $500,000 during the current or preceding calendar year. As qualifying digital products become taxable in 2027, companies should assess how those sales affect the threshold. Related-entity aggregation and the treatment of sales before the effective date may require additional analysis.
Example: a New York SaaS startup selling into California
A New York seed-stage startup sells standardized SaaS subscriptions and has no employees, offices or property in California. In 2027, its sales to California customers reach $600,000.
Once its California sales exceed the $500,000 economic-nexus threshold, the startup must register with CDTFA and collect tax on subsequent taxable sales. It must charge California’s 7.25% statewide base rate plus any district taxes applicable to the customer’s location.
Fact | Result |
Product | Standardized SaaS is a taxable digital product |
California sales | $600,000 exceeds the $500,000 nexus threshold |
Registration | The startup must register with CDTFA |
Collection | It must collect tax on subsequent taxable sales |
Rate | 7.25% statewide base rate plus applicable district taxes |
Customer location | Use the California customer address in the seller’s records |
When a seller does not have a duty to collect, the California purchaser may still have a use tax obligation. Product taxability and seller collection responsibility are related questions, but they are not the same question.
When must a SaaS company register and collect California sales tax?
A SaaS company should evaluate registration when it sells a taxable digital product to California customers and has established physical or economic nexus. Registration generally needs to be completed before the company begins collecting tax from customers.
The analysis should cover the full business, not only revenue from one product. Founders should review California sales, employees, contractors, property, marketplace activity and any existing California tax accounts.
Once registered, the company may need to collect the correct tax, file returns, remit the amount collected and maintain records supporting product classification, customer location and claimed exemptions.
Large transactions can require additional analysis. When a retailer’s aggregate sales of qualifying digital products to the same purchaser exceed $5 million, responsibility for reporting the tax may shift to the purchaser beginning with the transaction that crosses the threshold. This rule is separate from the $500,000 economic nexus threshold.
Which customer location and sales tax rate should a SaaS company use?
For a remote digital product sale, California generally determines the place of sale using the purchaser address in the seller records. The billing address is considered first, followed by the shipping or delivery address and then other available address information.
If the seller has no California address for the customer after making a reasonable effort to collect accurate information, the transaction may be treated as occurring outside California. Reliable address records are therefore part of the tax analysis, not merely a billing detail.
California has a statewide base sales and use tax rate of 7.25%. Local and district taxes may increase the total rate, so the amount charged can vary by customer location.
Products used in more than one state can require allocation and supporting records. A subscription used solely outside California may qualify for an exemption, while mixed use across California and other locations may need a reasonable allocation.
Do existing subscriptions and contracts become taxable in 2027?
Under CDTFA’s proposed Regulation 1600, a periodic subscription is treated as a continuing sale. Tax does not apply to subscription access before January 1, 2027, but it applies to access provided on or after that date, even when the contract was signed earlier.
For one-time sales, the key date is when the customer receives the right to access the software, not when payment is made. Software delivered and accessible in December 2026 remains untaxed even if the customer pays in 2027. Conversely, a customer who pays in December 2026 but receives access on January 1, 2027 is subject to tax.
Startups should review multi-year contracts, automatic renewals, prepaid subscriptions, implementation charges and bundled offerings. Contract language should also be checked to determine whether newly applicable taxes can be added to the customer invoice.
The correct treatment depends on the timing and structure of the transaction. Companies should avoid assuming that the contract date alone determines whether tax applies.
What should your startup do before January 1, 2027?
Start preparing early enough to identify gaps and update your billing process before the new rules take effect.
Check your California nexus. Review your sales and activities to determine whether you may have a registration obligation.
Classify each product and service. Consider subscriptions, features, add-ons and bundled services separately.
Clean up customer addresses. Make sure your billing and service-location data is complete and reliable.
Review contracts and renewals. Confirm that your agreements allow you to add applicable sales tax.
Register where required. Obtain the necessary permits before you begin collecting tax.
Set up and test collection. Configure your billing system to calculate and display the correct amount.
Plan your filing process. Assign responsibility for returns, payments, reconciliations and recordkeeping.
The right approach will depend on your products, customers, contracts and existing tax footprint.
Does SB 122 apply to B2B SaaS subscriptions?
SB 122 can apply to both business to business and consumer SaaS transactions. Selling software to another business does not automatically make the subscription exempt, although resale and other specific exemptions may apply when the seller receives valid documentation.
Can a California employee or contractor create sales tax nexus?
A California employee can create physical nexus even when the company remains below the economic nexus threshold. A contractor may also create nexus depending on the activities performed in California and the relationship with the company.
Are IaaS and PaaS products taxable under SB 122?
Qualifying digital infrastructure, including certain Infrastructure as a Service and Platform as a Service offerings, is excluded from the definition of a taxable digital product. The result depends on what customers can do with the service and how the offering is structured.
Does enabling Stripe Tax make a startup compliant?
Tax software can help calculate and collect the correct rate, but enabling it does not make a startup compliant by itself. The company must first determine nexus, classify its products, validate customer locations, register where required and file accurate returns.
How are bundled software, implementation and support fees taxed?
Bundled contracts require closer review because combining taxable software with implementation or support does not automatically make the full charge exempt. Separate pricing, contract language and the substance of each component can affect the treatment.
What happens if a startup fails to collect California sales tax?
If a startup was required to collect California sales tax but did not, it may need to pay the uncollected tax from its own funds, along with applicable interest and penalties. Correcting the issue early can reduce the amount that continues to accumulate and make customer remediation easier.
CDTFA digital products guide: Tax Guide for Sellers and Purchasers of Digital Products
California Legislature: SB 122 official bill text
CDTFA: Discussion paper and draft emergency regulations
CDTFA: Economic nexus guidance
CDTFA: California sales and use tax rates
CDTFA’s regulations are still in draft form and may change before implementation. This article provides general information and is not individualized tax advice.
This article is provided for general informational and educational purposes only. It does not constitute legal, accounting, or tax advice and should not be relied upon as a substitute for advice based on your company’s specific circumstances.
Tax rules and implementation guidance may change. Whether California sales tax applies depends on factors including your products, customer locations, physical presence, California sales, contracts, and filing history. Consult a qualified tax professional before making tax or compliance decisions.