California and Colorado recently enacted legislation that significantly changes the sales and use tax treatment of electronically transferred, prewritten software, including Software as a Service (SaaS). The changes will take effect from January 1, 2027.

California Will Begin Taxing Electronically Transferred and Remotely Accessed Prewritten Software

On June 29, 2026, California Governor Gavin Newsom signed Senate Bill 122 (SB 122) [1] into law as part of the state’s 2026–2027 budget package. The legislation expands California’s sales and use tax base by adding ‘digital product and any copyright or patent interests associated therewith’ to the statutory definition of tangible personal property. Under the new law, taxable ‘digital products’ are defined as prewritten computer software delivered on tangible media, transferred electronically, or accessed remotely.

The definition of ‘digital product’ excludes digital books, digital audiovisual works, digital music, digital video games, digital assets, and certain cloud-computing infrastructure that allows customers to develop, deploy, or operate their own software. Accordingly, businesses should not assume that all technology or cloud-based products are taxable digital products.

California Introduces Sourcing Rules for Digital Products

SB 122 introduces the ‘place of sale’ sourcing hierarchy applicable to sellers of digital products who are required to hold a California seller’s permit. SB 122’s ‘place of sale’ sourcing rules start by reiterating the ‘place of sale’ applicable for a digital product transferred on tangible media and then provide a sourcing hierarchy for electronically transferred or remotely accessed digital products based on the purchaser’s ‘known address,’ maintained in good faith in the seller’s records. When a purchaser provides more than one address, SB 122 requires the seller to determine the purchaser’s ‘known address’ in the following order of priority: purchaser’s billing address, then ‘shipping or delivery’ address, then the address tied to the purchaser’s payment instrument, and lastly, the purchaser’s ‘mailing address.’ If none of the sourcing hierarchy applies, the sale occurs outside California. The SB 122 ‘place of sale’ sourcing hierarchy contrasts with the sourcing hierarchies in several other states that prioritize customer instructions for delivery above the customer’s address maintained in the seller’s records.

SB 122 specifies a corresponding “place of use” rule that complements, but does not replace, the ‘place of sale’ rule, defined as ‘the place where any right or power is exercised over the digital product. Purchasers that buy from a seller not required to hold a California seller’s permit must follow the “place of use” rule. The rule also applies to purchasers who exceed five million dollars of purchases of digital products per calendar year from the retailer. Such purchasers are responsible for self-assessing and reporting use tax directly to the state. SB 122 also allows the California Department of Tax and Fee Administration (CDTFA) to waive the self-assessment requirement when such purchasers provide their list to the CDTFA with all the places where the purchaser expects to put the digital products to first use.

Out-of-State Use and Multiple Points of Use

SB 122 establishes that the CDTFA may authorize or require alternative methods to calculate California tax due that fairly reflects sales or use tax on sales of digital products that are concurrently available for use in multiple locations. While per-user billing models are naturally suited to the administrative ease provided for sellers via a customer’s Multiple Points of Use certificate, other types of billing models may pose challenges for the CDTFA’s learning curve as it enters the digital economy.

The CDTFA Digital Products Workshop, which took place on July 21, 2026 provided a forum for the public to weigh in on areas of SB 122 that may need clarification by regulation. CDTFA announced its intention to issue an emergency regulation no later than January 1, 2027.

Colorado Repeals Its Downloaded Software Exemption

Colorado House Bill 26-1223 (HB 26-1223) [2] also becomes effective January 1, 2027. The legislation repeals Colorado’s sales and use tax exemption for downloaded software, but preserves exclusions for:

• Software developed for use by a particular user, i.e., custom software.
• Downloaded software governed by a ‘negotiable license agreement’.

Sellers will need to evaluate whether the software license terms for their software products are substantively negotiable with their licensees, prior to or contemporaneously with the licensee’s access to or use of the software.

Colorado permits certain municipalities to administer and enforce their own sales and use taxes as self-collecting home rule jurisdictions. These cities are allowed to adopt tax bases, definitions, exemptions, and sourcing rules that differ from the state’s rules. For instance, the City of Denver has imposed sales and use tax on SaaS for several years.

A&M Tax Says

Prewritten software sellers should review their products and customer contracts to confirm their product characterizations correspond to the new rules for California and Colorado, paying special attention to bundled product offerings and managed services offerings. Customer service representatives should be provided with information and training to help them respond to customer questions, and customer records should be updated or established to capture customers’ user locations for purposes of accurate sales tax sourcing. Purchasers should likewise review their software purchases and should consider adding their user locations to their purchase orders and/or requesting the addition of user locations to their seller’s customer agreements. Proper sourcing and separately stated nontaxable charges, when available from sellers, may materially affect the amount of tax due.

Are your billing and purchasing policies and procedures ready for 2027? A&M Tax can help.

References

[1] California State Legislature, SB-122: Taxation, (leginfo.legislature.ca.gov,2026)

[2] Colorado General Assembly, HB26-1223: Modifying Certain Tax Expenditures, (leg.colorado.gov,2026)