Key Takeaways
- California Senate Bill 122 (SB 122) expands sales and use tax to certain digital products, including Software as a Service (SaaS), effective January 1, 2027.
- SB 122 adds sourcing rules for digital products and use tax obligations for businesses purchasing more than $5 million annually from a retailer.
- SB 122 extends the business credit limit, reduces first-year entity taxes and taxes certain federal settlement payments through 2030.
Governor Gavin Newsom signed Senate Bill 122 (SB 122) as part of California’s 2026–27 Budget Package. While SB 122, signed on June 29, 2026, includes several significant business tax provisions, the most notable change expands California’s definition of tangible personal property for sales and use tax purposes to include certain digital products. The details of this and other tax changes follow.
Digital Products (Effective January 1, 2027)
For sales and use tax purposes:
- Digital products are defined as prewritten computer software transferred on tangible storage media, transferred electronically, or accessed remotely.
- The term “purchase” includes any transfer of title or possession, exchange, or barter of a digital product transferred on tangible storage media. It also includes any right to open, view, access, download, copy, update, possess, store, manipulate or use a digital product transferred electronically or accessed remotely.
- The term “use” includes opening, viewing, accessing, downloading, copying, updating, possessing, storing or manipulating a digital product transferred electronically or accessed remotely. By inference, this includes software as a service (SaaS).
- Certain digital products exemptions generally include digital books, music, digital artwork and digital infrastructure. By inference, this includes platform as a service (PaaS).
- Businesses purchasing more than $5 million annually of qualifying digital products from a retailer may become responsible for self-assessing use tax. New customer-based sourcing rules determine where software transactions are taxed. Specifically:
- If a digital product is transferred on tangible storage media, the place of sale or purchase is where the tangible storage media is physically located at the time of sale (i.e., the place of destination).
- If it is not transferred on tangible storage media and is an in-person sale where the seller has a seller’s permit, the place of sale or purchase is the seller’s place of business.
- If it is not an in-person sale, the place of sale or purchase is the purchaser’s known address shown in the seller’s records.
Other Business Changes
- SB 122 extends California’s $5 million annual business credit limitation through taxable years beginning before January 1, 2030, with a revised limitation beginning in 2030.
- SB 122 further provides relief for newly formed entities doing business in the state by reducing the first-year minimum tax for LLCs, LLPs and Limited Partnerships from $800 to $400 for taxable years 2027 through 2029.
- SB 122 also imposes a 100% tax on certain settlement payments received from the federal Anti-Weaponization Fund, or any subsequent qualifying fund or settlement, for taxable years beginning on or after January 1, 2026 and before January 1, 2030.
Looking Ahead
Since SB 122 represents a significant shift in California’s taxation of digital products, taxpayers should begin evaluating its impact ahead of the January 1, 2027, effective date. We will keep you informed as additional guidance from the California Department of Tax and Fee Administration (CDTFA) is issued.
Contact Us
If you have questions related to these changes or need assistance with state tax issues generally, contact your PKF O’Connor Davies client service team or:
Steven J. Eller, CPA, JD
Partner
seller@pkfod.com
Nicholas Rochedieu, JD
Partner
nrochedieu@pkfod.com
Denisse Moderski, CPA
Partner
dmoderski@pkfod.com