Key Takeaways
- California’s new budget bill, S.B. 122, expands the state’s sales and use tax base to include prewritten software (whether it’s delivered physically, downloaded electronically, or accessed remotely as SaaS)
- Until now, California was one of the few states that didn’t tax electronically delivered or SaaS-based software. That loophole is now closed, and it will surprise businesses that were correctly advised in the past that no sales tax applied.
- Custom software remains exempt, but that is a very narrow class of software.
- The same budget bill also permanently caps California’s business tax credit and cuts the $800 minimum annual tax for new LLCs, LLPs, and partnerships to $400 through 2029.
- Ohio and Midwest businesses that sell or license software to California customers, or provide software as a service, even without a physical presence in California, should revisit their nexus and taxability position now, before an audit does it for them.
If you sell software into California, the advice you got a year ago may no longer hold.
Under California’s newly signed budget legislation, S.B. 122, the state is expanding its sales and use tax base to capture prewritten software regardless of how it’s delivered — physical media, electronic download, or software as a service. That closes a loophole that, until now, made California one of the more forgiving states for software sellers who avoided the sales tax question entirely on electronically delivered or SaaS products.
For a lot of Ohio and Midwest businesses that sell software, this isn’t a distant California problem. It’s a direct hit to companies we’ve worked with for years — companies we correctly told didn’t need to charge sales tax on their California sales, because at the time, they didn’t. That guidance was accurate when we gave it. It won’t be accurate much longer.
What’s actually changing
Previously, California taxed software delivered on physical media (think: a disc), but carved out an exception for software delivered electronically or accessed as SaaS. Under the new rules, that distinction disappears. Prewritten software is taxable in California no matter how it reaches the customer. Custom software — built specifically for one client, not sold or licensed broadly — stays exempt, so the line between “prewritten” and “custom” is about to matter a lot more than it used to.
This is the kind of change that catches good, careful businesses off guard — not because they weren’t paying attention, but because the rule they were following just moved.
Why this matters even if you’re nowhere near California
Sales tax nexus isn’t about where your office is. It’s about where your customers are and how much business you do there. If your company sells prewritten software or SaaS to California-based customers — even without an office, warehouse, or employee in the state — this change may create a new collection obligation you didn’t have before.
The businesses most likely to be caught off guard are exactly the ones who did things right the first time: they asked whether they needed to charge California sales tax, got an accurate “no,” and built pricing, contracts, and systems around that answer. That answer is changing on them through no fault of their own.
The smaller change worth a mention
The same budget bill also makes California’s business tax credit limit permanent (capped at the greater of $5 million per company or 50% of tax liability through 2029, rising to 70% starting in 2030) and cuts the $800 minimum tax for new LLCs, LLPs, and partnerships to $400 for tax years 2027 through 2029. Useful to know if you have California entity structures, but it’s a secondary story next to the software sales tax shift.
What to do now
Don’t wait for an audit notice to find out where you stand. If your business sells prewritten software or SaaS products and has any customer base in California, now’s the time to:
- Confirm whether your product qualifies as “prewritten” or “custom” software under the new rules.
- Review your California sales volume and customer footprint to assess your exposure.
- Update your point-of-sale or billing systems to reflect the new taxability determination before the change takes effect.
- Talk to your tax advisor before your customers — or the state — ask first.
This is a good moment to get in front of the conversation rather than react to it.
About the Authors
Sharon Uecker is a Sr. Manager on Rea’s State and Local Tax (SALT) team, specializing in sales and use tax compliance, multi-state tax issues, nexus and taxability analysis, voluntary disclosures, and audit defense. She brings over 14 years of sales and use tax advisory experience serving clients across manufacturing, retail, hospitality, financial services, and healthcare.
Joe Popp, JD, LLM, is a Partner on Rea’s State and Local Tax team, where he helps Ohio businesses and multistate companies navigate complex sales and use tax obligations. With a JD and LLM in taxation, Joe advises clients on nexus analysis, taxability determinations, and multi-state compliance strategy; helping businesses stay ahead of changes like California’s software tax expansion before they turn into audit exposure.
To connect with Sharon, Joe, or Rea’s SALT team, visit reaadvisory.com/contact.
