What does the California budget deal include regarding software taxation?

The California budget deal includes a provision to tax downloaded software and Software-as-a-Service (SaaS), expected to take effect in 2028.

How much revenue does the new software taxation proposal expect to generate annually?

The new software taxation proposal is estimated to raise $2 billion annually for California and local governments.

When will the new software taxation take effect in California?

The new software taxation is expected to take effect on January 1, 2028.

What types of software are subject to the new taxation in California?

Prewritten software, including SaaS, will be subject to the new sales tax in California.

California Extends Sales Tax to Digital Software and SaaS, Affecting Businesses

Q: Will custom software be exempt from the new taxation in California?

Custom software designed for an individual client will remain exempt from the new taxation in California.

California legislature passes bill to tax downloaded software and SaaS from 2027, raising $2B annually for the state. The proposal affects businesses, particularly those in the adult industry.

California has agreed to tax downloaded software for the first time as part of a $351.7 billion budget deal, raising an estimated $2 billion annually. The tax applies to prewritten software, including Software-as-a-Service (SaaS), and is expected to take effect in 2028.

What Happened

The California state legislature has passed a bill that extends the sales tax to digital prewritten software and SaaS, effective January 1, 2027. The proposal was initially recommended by Governor Gavin Newsom as part of his annual budget revision process in May. The bill, SB/AB 122, was approved by the Senate on June 18 with a vote of 28-10 and by the Assembly on June 15 with a vote of 56-20.

The tax is expected to raise $900 million for the state and another $1.1 billion for local governments starting in fiscal year 2028 and annually thereafter. The revenue generated from this new tax source will be used to support state spending under the proposed $356 billion budget agreement for fiscal 2027.

Background and Context

The current sales tax laws in California only apply to tangible goods, including software sold on physical discs. However, with the increasing shift towards digital transactions, the state's approach has resulted in a relatively narrow tax base in several areas, including software. The proposed change aims to bring online software closer to the way boxed or physical software is handled.

Custom software, which is designed for an individual client, will remain exempt from this new tax. However, prewritten software, including SaaS, will be subject to the sales tax regardless of how it is delivered. The proposal also clarifies that merely holding a license without action by the purchaser "to use the digital product to perform a task" does not constitute a taxable transaction.

Why It Matters to the Industry

The proposed tax on downloaded software and SaaS has significant implications for businesses operating in California, particularly those in the adult industry. The tax will apply to all prewritten software, including cloud-based tools that are used online. This means that companies could face new costs on tools they already rely on.

According to estimates, about 75% of the affected transactions are business-to-business software purchases. This makes the proposal especially important for companies that buy cloud tools for payroll, sales, marketing, design, cybersecurity, and customer service. A small extra charge on one subscription may not sound huge, but across many tools and many employees, the total cost can grow quickly.

What Comes Next

The proposal still needs to be approved by California lawmakers before it becomes law. The timing gives the Legislature, software companies, and business buyers time to react. It also means that the plan could still change before becoming law. If enacted, the tax will take effect on January 1, 2027.

Key Facts

The California state legislature has passed a bill extending the sales tax to digital prewritten software and SaaS, effective January 1, 2027.
The proposal was initially recommended by Governor Gavin Newsom as part of his annual budget revision process in May.
The tax is expected to raise $900 million for the state and another $1.1 billion for local governments starting in fiscal year 2028 and annually thereafter.
Custom software will remain exempt from this new tax, but prewritten software, including SaaS, will be subject to the sales tax regardless of how it is delivered.
The proposal clarifies that merely holding a license without action by the purchaser "to use the digital product to perform a task" does not constitute a taxable transaction.