At the beginning of June 2026, California Governor Newsom proposed expanding the state’s sales tax rules to cover all sales of prewritten, or “canned,” software as part of California’s 2026-2027 budget. On June 29, the Governor signed Senate Bill 122, expanding the scope of the state’s sales and use tax to include certain digital products.

New Sales Tax Rules for Digital Prewritten Software

Starting from January 1, 2027, sales and use tax will apply to digital prewritten software. Previously, California sales and use tax rules focused mainly on physical goods that could be seen, touched, or physically transferred, which generally meant electronically delivered software and cloud-based software access were not taxable.

The rules explicitly state that taxable transactions include transfers of rights to access, use, download, or manipulate digital products. As a result, most of the common technology services, including software-as-a-service (SaaS), subscription software platforms, hosted applications, and enterprise cloud solutions, will generally fall within California’s sales and use tax regime.

Notably, there are several important exclusions and limitations. Custom software developed specifically for one customer remains exempt from sales tax treatment. Also, certain digital entertainment and media products, including digital books, music, video content, and games, are excluded from the expanded definition. 

Additionally, the traditional distinction between taxable software and non-taxable services is maintained by exempting transactions in which the primary value derives from human effort performed after the customer’s request. This means that services such as consulting, professional advisory work, and some data processing activities may be tax-exempt if they are primarily service-based rather than software-driven. The law also introduces detailed sourcing rules critical to determining where a digital sale is taxed.

Another significant operational change introduced under California’s new digital software tax framework is the implementation of a USD 5 million threshold for digital product purchases. Starting in 2028, the threshold will apply to either the current or preceding calendar year. Once that threshold is exceeded, the obligation shifts from the seller to the purchaser, meaning the customer becomes responsible for self-assessing and remitting California use tax directly to the California Department of Tax and Fee Administration.

What This Means for Businesses

For businesses operating in California, the primary compliance challenge moves away from determining how software is delivered and instead focuses on properly classifying the transaction itself. More specifically, businesses must carefully evaluate the true nature of each transaction and determine whether the primary value being provided is automated software functionality or human-driven services. The new rules also place substantial administrative responsibility on sellers to collect, verify, and maintain accurate customer location information.