California’s new SaaS tax will hike software costs by 8-10% starting 2027

The Gist

• California SB 122 imposes 7.25% to 10.75% tax on SaaS and prewritten software
• The law redefines digital products as taxable tangible personal property
• Vendors and buyers face increased costs, with $2B projected annual state revenue

• California's new SaaS tax (SB 122) will apply to all prewritten software and SaaS products starting January 1, 2027, with rates ranging from 7.25% to 10.75%.
• The tax will impact both buyers and vendors, with many B2B companies needing to register with CDTFA for the first time due to nexus thresholds.
• Vendors with over $5M in sales to a single purchaser are relieved of collection obligations, shifting the compliance burden to the purchaser.
• AI application subscriptions are clearly taxable under SB 122, but consumption-based AI spend remains unresolved.
• Bundling services with software subscriptions can significantly impact tax liability, with one-line bundles being fully taxable.
• The infrastructure carve-out excludes IaaS and PaaS, but hybrid platforms combining infrastructure with application layers fall into a gray area.

• Restructure invoicing to separately state services from software subscriptions to reduce taxable amount.
• Prepare sales and customer success teams with explanations and concessions for affected accounts.
• Evaluate early renewal strategies for Q4 2026 to potentially avoid tax on straddling contracts.
• Classify SKUs as taxable/exempt and implement district-rate calculation based on billing addresses.

• 7.25% to 10.75% (California's SaaS tax rate (state + local))
• $2B (Projected annual revenue from the tax)
• $500,000 (Nexus threshold for remote sellers)
• $5M (Vendor-specific sales threshold shifting compliance to purchaser)