California is transforming the sales and use tax environment for online companies. Starting Jan. 1, 2027, SB 122 adds a new definition of taxable “tangible personal property” that covers certain “digital products” and raises new compliance concerns for software companies, online sellers and businesses that sell digitally delivered products.

What is taxable and when tax is due is going to be more important for businesses that sell software or electronic products to California consumers. Always look for an experienced tax professional (like a lawyer for tax return).

What Changes Does SB 122 Make?

The new rules encompass prewritten computer software that is transferred via physical media, electronically, or remotely, and cover “digital products.” But the law has a number of exceptions, such as digital books or digital audio and audio-visual works, digital video games, digital visual works, and digital infrastructure, as well as other types of digital assets.

This distinction is important because the existing guidance in California recognizes the distinction between electronically downloaded software, music, games, and like products and tangible storage medium, particularly when no tangible storage medium is provided.

Businesses will thus need to rethink their approach to digital product classifications and sales under the new framework.

Who Should Be Listening?

The changes might be more significant for:

SaaS and software companies.
Ecommerce companies that sell digital goods.
Online marketplaces
Companies that offer prewritten software that can be accessed remotely.

There are companies that are content and technology businesses with a mix of physical and digital products. There are businesses that have both content and technology, and they are physical and digital.

The businesses should not presume that just because they are not in California, they are not subject to California taxes. California sales and use tax regulations may impose liabilities for transactions that are subject to tax, as well as for transactions that are not subject to tax, but that involve activities or connections with the state.

A Practical Sales Tax Audit Roadmap

Companies should perform a thorough review prior to the implementation of new rules.

Identify all of the digital products.

Differentiate SaaS subscriptions, downloadable software, digital media, memberships, services, and physical products. Do not presume that all digital transactions are treated the same.

2.Check your customer locations

Know what transactions occur in California and how you currently check out customers and collect tax. Get a professional (like a tax attorney for IRS problems) who can help you during difficult times.

3.Check your "nexus position"

Examine the locations of employees, contractors, inventory, offices, economic activities, or other connections of your business that might impact your registration and collection requirements.

4.Check your tax software

Ensure the e-commerce platform or e-commerce tax engine can identify taxable digital products and the different kinds of digital products that are not taxable and apply the sourcing rules accordingly.

5.Review all invoices & records

Keep transaction-level records of product classification, customer location, tax collected, exemptions, and applicable documentation.

Suggestions for Getting Ready for 2027

Don't wait until January 2027 to make changes. Begin your testing now.

Businesses should:

Talk to a California tax expert about product taxability.
Use accounting systems to differentiate between taxable and non-taxable product types.
Test out checkout calculations before implementing them.
Follow California legislative and CDTFA guidance.
Make tax match sales records periodically.
Record the justification for product classifications.

SB 122 also adds sourcing rules and a special use-tax regime for various higher-volume electronically transferred or remotely accessed digital-product sales, which includes a $5 million threshold effective January 1, 2027.

California's digital tax landscape is becoming more complex. The important thing to note is that it is not enough for SaaS companies, software sellers, and online businesses to just accumulate more tax; they have to determine the correct products to be taxed, where the taxable activity is found, and when they are responsible for registration and collection of tax.

But businesses can use a proactive audit of product classifications, nexus, customer-location data, tax technology, and documentation to get ready for the upcoming year—before sales tax returns are due—rather than after.

New California Digital Sales Tax Rules Explained

California’s digital sales tax rules are going to change in 2027. Check all the details of SB 122, how it can affect your use of software, product classificatio