California’s new SB 122 makes most SaaS and digital prewritten software subject to California sales and use tax starting January 1, 2027. That’s a big deal for both software vendors and venture-funded startups that sell into or buy from customers in California.

For startups based in California, this means your software stack is likely to get more expensive. For startups based in other states that sell software in California, your billing and tax processes may need changes to keep up with the new rules.

Below is an overview of what SB 122 does, why it matters to startups, and how Kruze can help you get ahead of it.

What SB 122 Actually Does

SB 122 is part of California’s 2026-27 budget package and was signed into law on June 29, 2026. The law expands California’s sales and use tax base to include certain “digital products,” specifically prewritten computer software, starting January 1, 2027.

In practical terms, California now treats software‑as‑a‑service (SaaS) and other cloud-delivered prewritten software as taxable “tangible personal property,” whether it’s delivered on a physical medium, downloaded, or accessed remotely via the cloud. This is California’s first move to tax SaaS and other cloud‑delivered prewritten software at the statewide base rate plus any applicable local district rates.

What Counts as “Digital Prewritten Software”

Effective January 1, 2027, SB 122 defines a “digital product” as prewritten computer software transferred on tangible storage media, transferred electronically, or accessed remotely. “Prewritten” (or “canned”) software generally means software held or existing for general or repeated sale or lease, including software initially developed on a custom basis if later offered for repeated sale. As a result, many SaaS platforms will be taxable when they provide remote access to prewritten software, subject to the statute’s exclusions.

By contrast, custom software built specifically for a particular client is generally excluded from the tax base under the new framework. The law also focuses on transfers of rights to access, download, copy, update, store, or otherwise use prewritten software, regardless of the technical delivery method.

Effective Date and Tax Rates

The sales and use tax provisions of SB 122 apply to transactions occurring on or after January 1, 2027. California’s statewide sales and use tax rate is 7.25%, and SB 122 applies that base rate plus any applicable local district taxes to taxable digital prewritten software.

Because local district taxes stack on top of the state rate, the effective tax rate on software purchases can exceed 10% in some jurisdictions. Vendors and buyers will also need to consider existing nexus rules, which are the obligation to collect and remit taxes generally when sellers meet California’s economic or physical presence thresholds.

Companies that establish nexus in California under SB 122 or existing economic and physical presence standards may also have a California tax filing obligation. In addition to collecting and remitting sales tax, this can include registering with the state and filing appropriate California tax returns, depending on the nature and extent of their in-state activity.

How This Hits Venture‑Backed Startups As Software Buyers

If your startup is headquartered in California or has significant operations in the state, your existing SaaS stack is likely to become more expensive after January 1, 2027, due to the newly applied sales tax. That includes software like customer relationship management (CRM), applicant tracking systems (ATS), human resources information systems (HRIS), developer tools, analytics, and finance apps.

Vendors with a California sales tax obligation will generally be required to charge, collect, and remit tax on your startup’s subscriptions if they meet the nexus thresholds.

This change doesn’t mean you suddenly owe back taxes on prior‑year SaaS purchases, but it does mean your forward‑looking budget and burn projections should assume higher gross costs for taxable software. For many venture‑funded startups, software is a major line item, so even a mid‑single‑digit to low‑double‑digit effective tax rate can materially affect runway and cash‑flow planning.

How This Hits Startups That Are Software Vendors

If you sell prewritten software or SaaS to customers in California, SB 122 is effectively pulling you into the sales tax world for those transactions starting in 2027. The law amends definitions of “sale” and “purchase” to cover permanent or temporary transfers of rights to access or use prewritten software, including cloud‑based offerings.

For startups, this means you may need to register for California sales tax (Kruze can help you with this), update invoicing systems to add sales tax on California‑sourced transactions, and build processes to collect exemption certificates where applicable. It also increases the importance of classifying your offerings correctly – for example, distinguishing taxable prewritten software from potentially non‑taxable professional services, implementation, or custom development.

It’s also important to note that triggering nexus in California doesn’t just create a sales tax obligation. Depending on your footprint, it may also require your company to file California state tax returns, such as income or franchise tax filings, even if you are headquartered outside the state.

Custom vs. SaaS and Bundled Offerings

SB 122 and related guidance draw a line between prewritten software and custom software, with custom software generally remaining outside the expanded sales and use tax base. However, many startup offerings are bundles: A subscription to a core SaaS platform plus onboarding, consulting, and custom integrations.

How those bundles are structured and invoiced can influence the amount of tax owed! Separately stated, non‑software services may be treated differently from core prewritten software components.

Startups will need to review their contracts and billing practices to avoid accidentally subjecting non‑taxable services to tax simply because they are bundled into a single charge.

Why California Is Doing This

SB 122 is part of a broader effort to stabilize California’s revenue base and align its tax treatment of digital products with how many other jurisdictions already treat software and SaaS. For years, California taxed prewritten software delivered on tangible media. However, the state did not clearly tax software delivered electronically or via the cloud, which created both revenue loss and competitive differences compared to other states.

By redefining digital products as taxable tangible personal property, California closes that gap and broadens its tax base to a rapidly growing portion of the economy. The legislation also pairs the expansion with other revenue‑related provisions, such as extending limits on certain business tax credits and making adjustments to minimum taxes for some entities.

What Other States Tax SaaS?

California’s move to tax SaaS puts additional pressure on other states to update their rules on digital products and SaaS, especially as more of the economy shifts to subscription-based software. You can expect more states to consider this type of legislation or regulatory changes.

Here’s a quick overview:

  • Big states that tax SaaS: New York, Texas, Pennsylvania, Massachusetts, Washington, Ohio, South Dakota, Tennessee, and California starting in 2027. We’ve got a comprehensive guide for SaaS taxability you can review for more details.
  • Florida, Georgia, and several other states still tend to be more SaaS-friendly, but this could change over time.
  • Some home-rule cities, like Denver, can tax SaaS locally even if the state rules are more favorable.

In general, if your startup sells or buys SaaS across multiple states, you should expect the rules to continue to tighten. Because definitions, rates, and guidance change frequently, treat this as a high‑level snapshot, and contact us for specific information.

Planning Tips for Startup Software Buyers

For founders and finance leaders, SB 122 is a good excuse to revisit your software stack and budget before 2027 hits. Consider building a simple inventory of your major SaaS and software vendors, and flag which software is likely to be subject to California sales tax based on your nexus and billing footprint.

Then, model the impact of a 7.25%-10%+ tax on those recurring costs to understand how your burn and runway change under the new rules. This is also a natural time to negotiate contracts, re‑tier licenses, or consolidate tools so that you’re not paying tax on redundant or underused software.

Planning Tips for Startup Software Vendors

If you’re a SaaS or software startup selling into California, you’ll want to work with your tax advisor well before January 1, 2027, to get your compliance house in order. This typically includes confirming whether you have nexus in California, registering for sales and use tax if required, and configuring your billing systems to apply the correct rates based on customer location.

As part of this process, confirm whether your nexus exposure also creates a broader California tax filing requirement. Many startups focus on sales tax compliance first, but California may expect qualifying businesses to file state tax returns once nexus is established.

Documentation will matter: Clearly describing what you sell (prewritten software vs. custom dev vs. services) and how you price it can support your tax treatment if California ever asks questions. You may also want to update your customer communications to explain that sales tax is being added due to a law change rather than a pure price increase.

How Kruze Can Help

SB 122 touches both sides of the startup world: Founders buying software to run their companies and founders selling software to fund their companies. Because the law doesn’t kick in until January 1, 2027, there is still time to get your systems, chart of accounts, and budgeting processes aligned with the new rules.

At Kruze, we’re already tracking how California and other states are approaching digital products so that our venture‑backed clients can stay compliant without drowning in sales tax complexity. If you want help modeling the impact of SB 122 on your runway, or building a workable sales tax strategy for your SaaS startup, we’re happy to help.

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SB 122 FAQ for Startups

When does SB 122 start applying to SaaS and digital software?

SB 122’s expansion of sales and use tax to digital prewritten software, including SaaS, applies to transactions on or after January 1, 2027.

If I had $10,000 in California SaaS sales, how much should I collect in California SaaS Sales Tax?

Approximately $800.

Does my startup have to eat this new tax/cost?

No, not necessarily. However, if you’re a startup selling SaaS to California clients, you should notify your client base NOW that you will be charging CA Sales Tax starting Jan. 1, 2027. You should also amend your sales contracts to include a disclaimer that SaaS Tax might be applicable in CA, starting Jan. 1, 2027.

What should I tell my clients?

Send them a notification email NOW. Explain that a new state law (SB 122) will require sales taxes on many software subscriptions beginning Jan. 1, 2027, and they’ll see a new tax line item on their invoices once the rules take effect.

Does SB 122 tax all digital products?

No. SB 122 focuses on prewritten computer software, including software delivered on physical media, downloaded, or accessed remotely, and does not automatically tax every digital good. Many purely digital content products and certain custom software arrangements may fall outside the scope, depending on how they are structured.

I run a SaaS startup outside California. Do I still need to worry about this?

Potentially, yes. If you sell prewritten software or SaaS to customers in California and meet the state’s economic or physical nexus thresholds, you may be required to collect and remit California sales tax under SB 122. Location of your HQ alone doesn’t shield you if your sales into California cross those thresholds.

Will my startup owe back taxes on prior SaaS purchases because of SB 122?

Current guidance and commentary indicate that SB 122 applies to transactions occurring on or after January 1, 2027, rather than retroactively taxing prior SaaS purchases. That said, it’s still important to monitor any future administrative guidance for nuances in implementation, and we’ll post any updates when new guidance is issued.

How should I classify my product if it’s part software, part services?

Under SB 122, prewritten software components are generally taxable, while certain custom development and professional services may not be. Because classification can be fact‑specific and heavily influenced by contracts and invoicing, most startups will want to work with a tax advisor to structure offerings and documentation appropriately.