California

For decades, California was among a minority of states that did not impose sales and use tax on prewritten software delivered electronically or remotely accessed. Effective January 1, 2027, under the recently enacted S.B. 122/A.B. 122, 2025-2026 Reg. Sess. (Cal. 2026), tangible personal property to which California sales and use tax applies has been expanded to include a digital product. The term “digital product” means prewritten computer software transferred on tangible storage media, transferred electronically, or accessed remotely, and thus, subjects to California sales and use tax the purchase, sale, or use within California of prewritten digital software and SaaS.

Under S.B. 122, the definition of a taxable sale or purchase is expanded to include the transfer of any temporary or permanent right to open, view, access, download, copy, update, possess, store, manipulate, or otherwise use a digital product transferred electronically or accessed remotely for a consideration. Similarly, the definition of taxable use is expanded to provide that the taxable exercise of any right or power over tangible personal property includes opening, viewing, accessing, downloading, copying, updating, possessing, storing, or manipulating a digital product transferred electronically or accessed remotely.

The new law is otherwise limited in scope, as retail sales of custom software remain primarily non-taxable, and certain categories of digital products, such as digital books, audio works, audiovisual works, and video games, are not subject to the tax. Further, services related to digital software and SaaS – but not the digital software and SaaS itself – remain exempt if they primarily involve the “application of human effort by the service provider” that originates after the customer requests the service.

The new law provides that the sale or purchase of electronically delivered or remotely accessed prewritten software is deemed to have occurred at the purchaser’s “known address” in California, as provided to the seller during the consummation of the sale or purchase, or if no such address was provided with respect to the current sale or purchase, then as most recently provided by the purchaser to the seller. California will apply a hierarchy to determine a purchaser’s known address in California, looking first to:

1. the purchaser’s billing address, then to
2. the purchaser’s shipping or delivery address, then to
3. the mailing address associated with the purchaser’s payment instrument, and then to
4. the purchaser’s mailing address.

If the purchaser has no California address, pursuant to the foregoing, the place of sale or purchase of the digital product is deemed to be outside California and a retailer is not required to pay sales tax or collect use tax with respect thereto so long as the retailer can demonstrate that it made a reasonable effort to obtain accurate and complete address information from the purchaser.

Where electronically delivered or remotely accessed prewritten software is deemed to have been purchased outside California, but is then used in California within 90 days of the date of sale or purchase, the software is presumed to have been purchased for use in California and subject to California use tax. The place of use of a digital product is the place where any right or power is exercised over the product, while the right or power to remotely access a digital product is exercised at the location from which a person accesses the software.

Unlike other states, S.B. 122 does not contain any mechanism for the allocation of sales and use tax liability where a license or subscription for digital software or SaaS is acquired by a purchaser for use by individuals who are located across multiple states. Thus, retailers and purchasers will have no specific guidance on such multistate allocation unless and until the California Department of Tax and Fee Administration (CDTFA) promulgates regulations providing a methodology. Presumably, such regulatory action will be forthcoming, as the failure to provide for such multistate allocation would be constitutionally suspect.

Retailers are not obligated to pay sales tax or collect use tax on the sale or purchase of digital products transferred electronically or accessed remotely where the gross receipts from the sale of digital products to a purchaser or the sales price of digital products purchased by a purchaser exceeds $5,000,000 in the aggregate in the current calendar year, or beginning January 1, 2028, in the current or the preceding calendar year. Starting with the transaction that caused the $5,000,000 threshold to be met, the purchaser becomes obligated to obtain a use tax direct payment permit and self-assess and remit directly the use tax due on its purchases. However, the CDTFA can waive at the request of the purchaser the requirement for self-assessment and payment of use tax, which waiver would then require the retailer to continue to pay sales tax or collect use tax, as applicable.

The new law will align California with the majority of other states that impose sales and use tax on digital products in one manner or another and will likely generate substantial revenue over time. Businesses that sell prewritten digital software or SaaS to customers either located in California or otherwise using the software or SaaS within California should start preparing well ahead of the January 1, 2027, effective date to:

• determine whether the business’s products have become subject to California sales and use tax;
• if the business does not currently have nexus with California, evaluate whether the change in the treatment of digital software and SaaS will establish economic nexus with California;
• communicate the change in taxability to their customers and gather the necessary information from customers to properly determine the sourcing of their sales of digital products to California (including any information that may be necessary to allow for multistate allocation once addressed by the CDTFA), as well as gather necessary exemption certificates from customers;
• consider and implement changes in invoicing and contracts to separate state charges for taxable digital products from charges for non-taxable items such as custom software or modification to prewritten software;
• coordinate with their sales and use tax compliance providers to ensure that their compliance software is updated correctly to apply the change in law as of January 1, 2027; and
• make appropriate registrations with the CDTFA.

Colorado

While many local home rule taxing jurisdictions in Colorado have historically imposed their sales and use tax on prewritten software delivered electronically or remotely accessed, the state-level sales and use tax imposed by Colorado has not, requiring that the software be delivered via a tangible medium in order to be subject to tax. That will change effective January 1, 2027, following the enactment by Colorado of HB 26-1223 on June 4, 2026, which removes the statutory requirement for delivery via a tangible medium. Instead, all prewritten software, regardless of delivery method, including digital software and SaaS, is subject to Colorado sales and use tax, absent a specific exemption. The new law generally leaves in place existing exemptions, for example, exemptions for custom software.