A software agreement signed in 2026 may still be subject to California sales tax in 2027. The date you signed the contract or paid the invoice does not necessarily determine whether tax applies.
Beginning January 1, 2027, California will impose sales and use tax on many digital software products, including software as a service (SaaS). The change was enacted under Senate Bill 122 in June 2026.
For companies selling or purchasing software, the timing matters. A subscription paid for in December 2026 could still be taxable if it covers access beginning in 2027.
The California Department of Tax and Fee Administration (CDTFA) has released draft regulations addressing these situations. Although the regulations are not final, they provide useful guidance for businesses reviewing their existing agreements.
01Does Paying for a 2027 SaaS Subscription in December 2026 Avoid Sales Tax?
Generally, no. Under the proposed regulations, paying for software before January 1, 2027 does not necessarily avoid tax if the customer's right to access the software begins in 2027.
The CDTFA provides several examples that illustrate the difference.
Example 1: Paid in 2026, access begins in 2027
A customer pays for a software license on December 15, 2026, but cannot access the software until January 1, 2027.
Under the proposed rules, the transaction is taxable.
Example 2: Software delivered in 2026, payment made in 2027
A customer purchases electronically delivered software on December 15, 2026 and receives immediate access. The customer does not pay until January 2027.
Under the draft regulations, the sale is not subject to the new tax because the transaction occurred before the effective date.
Example 3: A subscription begins in 2026 and continues into 2027
A customer signs up for a 12-month software subscription in December 2026.
The draft treats periodic subscriptions as continuing sales. Charges for the right to access the software in 2026 are not subject to the new tax, while charges for access beginning January 1, 2027 are taxable.
These examples illustrate an important distinction between an ongoing subscription and a completed software sale.
For a completed sale, the date the customer receives the right to access the software can determine the tax treatment. For a continuing subscription, the period covered by the subscription matters.
The CDTFA's draft Regulation 1600 explains these transitional rules in Exhibit 4.
02Will Existing SaaS Contracts Be Taxed in 2027?
Yes, existing contracts can become taxable even if they were signed before the new law takes effect.
Consider a company that signed a three-year SaaS agreement in July 2025. The agreement runs through June 2028.
Under the draft regulations, continuing subscription charges attributable to 2027 and later periods would generally become taxable, assuming the software and transaction are otherwise taxable in California.
The original contract date does not automatically protect future subscription periods.
Companies should also review who is responsible for paying any newly applicable taxes.
Some contracts allow vendors to add sales tax to existing subscription charges. Others may have different pricing or tax provisions.
For SaaS vendors, this can affect billing systems, invoices, and customer communications. For buyers, it can mean higher software expenses even when the original contract price has not changed.
03Are Cloud Infrastructure, APIs, and AI Software Taxable?
California's new law covers prewritten software accessed remotely, including SaaS applications. However, it does not treat every cloud-based product the same way.
The law excludes certain digital infrastructure services, including qualifying Infrastructure as a Service (IaaS) and Platform as a Service (PaaS).
These services generally allow customers to create, deploy, scale, or run their own software using a provider's infrastructure.
For example, a company purchasing cloud computing capacity to host its own application may qualify for the digital infrastructure exclusion.
A company purchasing access to a finished, cloud-hosted application would generally be purchasing taxable SaaS.
What About AI Software and APIs?
This distinction becomes more complicated with AI products.
A company might sell an AI chatbot, an automated document review tool, or access to an AI model through an API.
The tax treatment depends on what the customer is actually purchasing.
If the customer is paying to access prewritten software through an API, that access may fall within the taxable SaaS definition. An API does not automatically make the product an excluded infrastructure service.
AI products also do not automatically qualify as custom software merely because they generate personalized responses.
The CDTFA's draft regulations include an example of an AI-powered tax analysis tool. Even though the tool is trained to provide specialized California tax recommendations, it does not qualify as custom software because the underlying system is offered to multiple customers.
Software created specifically for one customer may qualify for different treatment. Separately stated charges for qualifying custom modifications may also be exempt.
For startups developing AI products, the distinction between prewritten software, custom development, and digital infrastructure deserves attention before 2027.
04What If Your Employees Use Software Inside and Outside California?
Many startups purchase software centrally but have employees working across multiple states.
Suppose a company purchases 100 software licenses for its employees:
- 25 employees work in California.
- 75 employees work in other states.
Does California sales tax apply to the entire purchase?
Not necessarily.
California's proposed rules allow reasonable methods to allocate purchases of digital products used in multiple locations.
For example, a company may be able to allocate the cost based on the number of users or computers inside and outside California. Under the proposed methodology, 25% of the cost in this example could be attributable to California.
The company would need records supporting that allocation and, where applicable, a multiple-points-of-use (MPU) certificate provided to the vendor.
The CDTFA also specifically states that allocating software purchases based on the location of the servers where the software is installed is not a reasonable method.
A server located outside California does not establish that the software is used outside California.
For companies with distributed teams, employee locations, license assignments, and usage records may become important documentation.
05What Should SaaS Companies Do Before January 1, 2027?
With the effective date approaching, companies should review their existing agreements and billing practices.
For software vendors, the priorities include determining which products are taxable, reviewing registration and collection obligations, updating billing systems, and identifying customers who may qualify for exemptions or multistate allocations.
For software buyers, the priorities are slightly different. Review upcoming renewals, identify subscriptions that will cover 2027 periods, and determine whether purchases are used across multiple states.
Companies should pay particular attention to:
- Contracts signed or prepaid in 2026 that provide access during 2027.
- Products combining SaaS functionality with cloud infrastructure or custom development.
- Enterprise software purchased for employees in multiple states.
Businesses should also remember that a vendor's failure to collect California sales tax does not necessarily eliminate the purchaser's use tax obligation.
The CDTFA has published a Digital Products Tax Guide explaining the new law, exemptions, and responsibilities of sellers and purchasers.
06The Bottom Line
California's SaaS sales tax takes effect January 1, 2027, but companies should be reviewing their contracts now.
Signing or paying for a software agreement in 2026 does not necessarily prevent the new tax from applying in 2027.
The outcome depends on the type of software being purchased, when the customer receives access, whether the transaction is a continuing subscription or a completed sale, and where the software is used.
The new law is enacted, but the CDTFA's implementing regulations remain subject to change. Companies should review the final regulations when issued, particularly for contracts spanning the effective date.
For startups selling SaaS, AI products, or software to customers across multiple states, understanding these distinctions before 2027 can help avoid unexpected tax costs and billing problems.
Talara works with startups and growing companies on federal and state tax compliance. If your business is preparing for California's 2027 software tax changes, we can help identify tax considerations and coordinate specialized sales tax guidance where needed.
This article is general information, not tax or legal advice. The rules are fact-specific, change over time, and depend on details unique to your company. Talk to us about how they apply to your situation.