A new California tax on business software is expected to generate roughly $2 billion each year once fully implemented, according to an analysis published by the Pacific Research Institute. The tax, signed into law by Governor Gavin Newsom on June 29 as Senate Bill 122, takes effect January 1, 2027, and extends California's sales and use tax to remotely accessed software that's become a standard tool for modern businesses. The report warns the legislation doesn't just make software more expensive — it creates the framework California would need to tax other parts of the digital economy in the future.
The administration projects the tax will collect $450 million for the General Fund and $560 million for local governments during its first six months of operation. Once the tax is running at full capacity, those figures climb to $900 million and $1.1 billion per year respectively, totaling approximately $2 billion annually. During a Senate Budget Committee hearing, Department of Finance official Colby White estimated that businesses account for roughly three-quarters of software purchases. The law broadens California's definition of tangible personal property to cover prewritten software in any form — whether delivered on a disc, downloaded, or accessed remotely through software as a service (SaaS). Custom software created for a specific client remains exempt from the tax.
According to the report, the California Department of Tax and Fee Administration held a workshop on July 21 to determine which portions of SB 122 need clarification and which issues might require emergency regulations before implementation. The report notes that businesses now have less than five months to prepare for a tax whose administrative details are still being worked out, with questions remaining about how to calculate the tax when software licenses are used across multiple locations. The nonpartisan Legislative Analyst's Office cautioned that a large portion of the newly taxed transactions will be business-to-business sales, and that taxing business purchases can drive up costs for consumers while favoring large, vertically integrated companies over smaller firms that must buy software and services from outside vendors.
The report explains that these programs aren't luxuries limited to technology companies — restaurants use subscription software for payroll and scheduling, medical offices rely on it for billing and patient administration, and manufacturers depend on it to track inventory. Small businesses use software for accounting, communication, marketing, customer management, and countless other daily operations. Because the tax appears first on a business's software bill rather than a customer's receipt, most Californians may easily overlook it, but that doesn't mean consumers will escape the cost. Businesses don't simply make those costs disappear — they have to absorb higher expenses somehow, whether through higher prices, smaller margins, or less money available for hiring and investment.
While video games, e-books, streaming video, and music remain outside the tax today, the legislation establishes the definitions, sourcing rules, and collection mechanisms for taxing remotely delivered or accessed digital products. The Legislative Analyst's Office has already recommended extending the sales tax to a broader range of digital products rather than limiting it to software, citing the goal of eliminating distinctions between taxed and untaxed products. When lawmakers next face a budget shortfall, they won't need to build an entirely new system for taxing digital commerce — they could simply amend those exclusions and expand the framework now being put in place. The report's bottom line: Californians shouldn't be surprised if today's software tax becomes tomorrow's tax on the rest of our digital lives.