What California's New SB 122 Means for the Software Your Business Already Relies On
For nearly three decades, California maintained a simple distinction when it came to software sales tax.
If you purchased software on a physical disk or downloaded a prewritten program, you generally paid sales tax. But if you accessed that same software through the cloud as Software-as-a-Service (SaaS), it typically wasn't subject to California sales tax.
That distinction is coming to an end.
On June 29, 2026, Governor Gavin Newsom signed Senate Bill 122 (SB 122) as part of California's state budget package. While much of the legislation focused on budget matters, one provision stands out for businesses of every size: beginning January 1, 2027, many digital products, including prewritten software and SaaS, will become subject to California sales and use tax.
If your business relies on cloud-based software to manage accounting, customer relationships, payroll, project management, or daily operations, this change could increase your technology costs without adding any new functionality.
What Actually Changed?
SB 122 expands California's sales and use tax to include many digital products, specifically:
- Prewritten software
- Software-as-a-Service (SaaS)
- Cloud-based software subscriptions
- Remotely accessed software
Under the new law, it no longer matters whether software is installed on your computer, downloaded from the internet, or accessed entirely through a web browser. If it's prewritten software offered to multiple customers, it will generally be taxable beginning in 2027.
For many businesses, this means software that has historically been tax-free will now include an additional sales tax charge on every invoice.
Which Software Could Be Affected?
While the law doesn't target specific brands, many businesses rely on cloud-based platforms that may now be subject to sales tax.
Examples include software used for:
- Accounting and bookkeeping
- Customer relationship management (CRM)
- Payroll processing
- Human resources
- Project management
- Team collaboration
- Marketing automation
- Inventory management
- Business analytics
For many organizations, these subscriptions have become essential operating expenses rather than optional tools.
Are There Any Exceptions?
Yes.
SB 122 does not apply to every type of digital product.
One of the most significant exceptions is custom software developed specifically for a single customer. Because custom-built software is created for an individual business rather than sold as an off-the-shelf product, it generally remains exempt from the new sales tax rules.
The legislation also excludes certain other digital products, including:
- Digital books
- Streaming media
- Video games
- Cryptocurrency transactions
However, for the average business, the majority of everyday SaaS subscriptions are expected to fall within the scope of the new law.
Why This Could Cost More Than You Think
At first glance, adding sales tax to a software subscription may not seem like a major expense.
An extra few dollars on one monthly subscription doesn't usually raise concerns.
But businesses rarely rely on just one software platform.
Consider a company that uses:
- Accounting software
- A CRM platform
- Payroll software
- Project management tools
- HR software
- Marketing platforms
- Cybersecurity services
- File storage and collaboration tools
Individually, each subscription may appear relatively inexpensive.
Collectively, however, they can represent thousands, or even tens of thousand, of dollars in annual software expenses. Applying California sales tax across an entire technology stack can create a noticeable increase in operating costs that wasn't previously part of the budget.
For growing businesses, this is exactly the type of recurring expense that can quietly impact profitability if it isn't planned for in advance.
What Businesses Should Do Before January 2027
Although the new tax doesn't take effect until January 1, 2027, businesses have an opportunity to prepare now.
Consider taking these proactive steps:
Review Your Software Subscriptions
Create a complete inventory of every software subscription your business currently pays for.
This includes monthly and annual services across every department, not just accounting.
Understanding your total software spend will help estimate how much additional sales tax your business may incur once the law takes effect.
Review Vendor Agreements
Some vendors may list the tax as a separate line item on invoices, while others may incorporate it into pricing.
Understanding how your software providers intend to handle the new tax can help avoid surprises.
Update Budgets for 2027
If your business depends heavily on cloud-based software, factor the additional tax into future operating budgets and cash flow projections.
Preparing now allows you to make informed financial decisions before the first taxable invoices arrive.
Review Accounting and Procurement Processes
Accounting teams may need to update purchasing procedures, invoice reviews, and expense tracking to ensure software purchases are recorded accurately under the new tax rules.
Planning ahead can reduce administrative challenges once implementation begins.
Other Important Changes Included in SB 122
Although the software tax has received the most attention, SB 122 contains several additional provisions that businesses should be aware of.
Business Tax Credit Limitations Continue
The legislation extends California's existing $5 million limitation on the use of certain business tax credits through 2029.
Businesses that rely on research and development credits or other significant tax incentives should review how these limitations may affect future tax planning.
Beginning in 2030, a revised framework for applying these limitations is expected to take effect.
Reduced First-Year Annual Tax for Certain New Entities
SB 122 also provides limited relief for newly formed LLCs, LLPs, and LPs.
For qualifying entities formed during tax years 2027 through 2029, the first-year annual California tax is reduced from $800 to $400.
While modest, this change may provide meaningful savings for entrepreneurs launching new businesses during the applicable period.
The Bottom Line
SB 122 is no longer a proposal, it's law.
The question isn't whether these changes are coming. The question is whether your business will be prepared before they arrive.
Businesses that review their software subscriptions, evaluate vendor contracts, and update financial projections now will have more time to adapt before the new tax takes effect in 2027.
Waiting until the first invoice arrives with unexpected sales tax could make budgeting and forecasting much more difficult.
Ready to Prepare for SB 122?
Tax law changes often create questions about budgeting, compliance, and long-term financial planning. Having a proactive strategy can help your business avoid surprises and make informed decisions before new rules take effect.
At Scout Financial, we help business owners navigate changing tax laws, evaluate their financial impact, and develop practical strategies that support long-term growth. Whether you need assistance understanding SB 122, reviewing your software expenses, or creating a tax plan that aligns with your business goals, our team is here to help.
Contact Scout Financial today to schedule a consultation and prepare your business for California's evolving tax landscape with confidence.
