For years, California treated software differently depending on how it was delivered. Software shipped on a physical device was generally subject to sales tax. Software downloaded from the internet or accessed through the cloud usually wasn't.
That changes on January 1, 2027.
If your company sells SaaS to California customers, this is a change worth preparing for now. If your business buys a lot of software, your technology costs may also increase.
01What is changing?
The biggest change is simple:
Most standard software subscriptions sold to California customers will become subject to California sales tax.
Historically, many SaaS companies didn't need to collect California sales tax because customers were accessing software remotely rather than receiving physical software.
That distinction is going away.
02What will generally be taxable?
Beginning January 1, 2027, California generally intends to tax:
Generally TaxableGenerally Not TaxableSaaS subscriptionsCustom software built specifically for one customerDownloaded softwareSeparately billed custom developmentStandard cloud softwareMany professional services requiring significant human effortStandard AI software platformsInfrastructure as a Service (IaaS)
One important exception involves software customization. If you're modifying prewritten software for a client, only the custom portion may qualify for different treatment, and only if it is separately stated on the invoice.
03Why founders should care
Even if your company isn't in the tax business, this change can affect pricing, contracts, billing systems, and cash flow.
Questions worth asking include:
- Do we need to start collecting California sales tax?
- Does our billing platform support California's new rules?
- Should our customer contracts address sales tax?
- Will our software vendors begin charging us additional tax?
These aren't issues you want to discover after invoices have already gone out.
04Multi-state companies may face additional complexity
Many startups sell software nationwide.
California's new rules don't fully explain how to allocate a subscription used by employees across multiple states. Additional guidance is expected, but companies with enterprise customers should pay attention as those rules develop.
05Large enterprise contracts
The law also includes a special rule for very large customer relationships.
If sales of digital products to a single customer exceed $5 million during a calendar year, the responsibility for paying the tax may shift from the seller to the buyer. While this won't affect most startups, companies with large enterprise customers should understand how the rule works.
06Other provisions founders should know about
The legislation also extends California's limitation on the use of certain business tax credits for several more years.
For newly formed California LLCs, LPs, and LLPs, there is some welcome news. The first-year minimum franchise tax is temporarily reduced from $800 to $400 for entities formed during 2027 through 2029.
07What should companies do now?
Although the rules don't take effect until January 1, 2027, it's a good time to prepare.
Review your products to determine which offerings may become taxable. Evaluate your billing and invoicing systems to ensure they can properly calculate California sales tax. If you provide both software and professional services, consider whether invoices should separately identify custom work. Finally, review customer agreements to make sure they clearly address sales tax and other indirect taxes.
Companies with significant California revenue or enterprise customers may also want to model the financial impact before the rules become effective.
08Final thoughts
For many software companies, this is the biggest change to California's sales tax rules in years.
Some businesses that have never collected California sales tax may need to begin doing so in 2027. Others may simply see higher software costs as vendors start charging tax on subscriptions.
The good news is that there is still time to prepare. Reviewing your products, billing systems, and customer contracts now can help avoid surprises once the new rules take effect.