SB 122 Expands California Sales and Use Tax to Software

SB 122 Expands California Sales and Use Tax to Software California has enacted Senate Bill 122, which expands the taxation of software and restricts certain local tax sharing agreements. Sales and Use Tax on Software Beginning January 1, 2027, California sales and use tax will expand to apply to many subscriptions to software as a service and other prewritten software delivered electronically or accessed remotely. Local agencies may begin paying tax on qualifying software used for finance, payroll, permitting, utility billing, records management, public safety, cybersecurity, and other municipal operations. The change may affect new contracts and existing agreements with payments or renewals occurring on or after January 1, 2027.

Qualifying custom software and certain digital infrastructure and services remain excluded or exempt. Agreements that combine software with implementation, training, consulting, or other services may require further review.

SB 122 may also affect city or district revenues. For covered software transactions, the local share of the tax will generally be allocated based on the purchaser address maintained by the software vendor, often the billing address, rather than the location of the software company. A city may therefore receive additional local tax revenue when businesses and other customers located within the city purchase taxable software.

Restrictions on Tax Sharing Agreements

Effective June 29, 2026, SB 122 prohibits charter and general law cities from entering into agreements that rebate, transfer, divert, or share Bradley Burns revenue generated by digital products transferred electronically or accessed remotely.

Cities should review pending and proposed tax sharing or economic development agreements involving software vendors or other digital product retailers. Existing agreements should also be reviewed before they are amended, renewed, extended, or used as the basis for future payments.

Recommended Actions

Cities and districts should:

• Identify software contracts and renewals extending beyond January 1, 2027.

• Determine whether contract pricing includes applicable taxes.

• Account for potential increases in software costs.

• Confirm that billing information provided to software vendors is accurate.

• Review agreements that combine software with implementation or other services.

• Review pending and existing tax sharing or economic development agreements involving digital products.

CDTFA Implementation

CDTFA held a Digital Products Workshop on July 21, 2026. At the workshop, CDTFA indicated that emergency regulations addressing significant implementation issues are expected in late August or early September, followed by a five day public comment period. CDTFA will then begin the regular rulemaking process, which may take approximately two years. The emergency regulations are expected to address issues including the allocation of licenses used both within and outside California and subscriptions entered into before January 1, 2027, but used after that date. Any exemption for local agencies would require separate legislation.

Our Public Finance Group can assist cities and districts in evaluating the fiscal and local revenue implications of SB 122 and reviewing affected tax sharing arrangements.

For additional information, see the official text and history of SB 122 here.