California’s software and SaaS tax shift: What digital sellers should know

For decades, states generally could only require sellers to collect sales tax if they had an in-state physical presence, such as an office, warehouse, or employees. The 2018 Supreme Court decision in South Dakota v. Wayfair changed that by allowing states to require remote sellers to collect sales and use tax based on economic activity. Today, sellers must monitor where they sell, how much they sell, and whether they have crossed state economic nexus thresholds.

Consumers and retailers often only consider the taxability of tangible personal property: any physical, movable item that can be seen, weighed, measured, felt, or touched. But in the current world of e-commerce, digital downloads, streaming, and online marketplaces, states are expanding their sales tax base to include more enumerated services, digital products, and goods which are in any other manner perceptible to the senses.

California is an especially important market. As the fourth-largest economy in the world by GDP, it is also one of the world’s largest consumer markets. Beginning 01 January 2027, California will expand its sales and use tax rules to include certain digital products, including prewritten software and software as a service (SaaS), whether delivered electronically or accessed remotely. However, digital assets, digital infrastructure, digital books, digital audio, and visual works will remain non-taxable.

While software faces a tax, services like data processing, consulting, implementation, support, analytics, or managed services that come with software offerings may remain non-taxable when the value of the transaction primarily comes from human effort performed after the customer requests the service. Separately stating service charges on contracts and invoices may become more important, so vendors can support which portions of a bundled offering are taxable and which may qualify as non-taxable services.

This is a significant shift for many foreign and domestic software and SaaS sellers that historically paid less attention to California because electronically-delivered software and cloud-based subscriptions were outside the state’s sales tax base. With the effective date just a few months away, businesses with California operations or customers should consider how this law change will impact registration, collection, filing, and sourcing.

The shift in California’s tax law should be a wake-up call for digital sellers that haven’t concerned themselves with sales tax ramifications. Foreign and domestic companies should use this as an opportunity to perform a nexus analysis, review product taxability by state, and confirm whether they need to register, collect, or file. They should also evaluate historical exposure, exemption processes, billing systems, contract language, and whether a voluntary disclosure agreement could help limit penalties or lookback periods.

---

Michael Szewc, state and local tax director at Mowery & Schoenfeld, specialises in guiding large organisations through complex state and local income, sales and use, and franchise tax challenges. He also serves as North American Regional Chair of GGI’s ITPG, connecting global expertise with practical solutions