ABOUT THE EXPERTS

Dorothy Lo is a Partner in PwC's San Francisco office. With over 20 years of experience, she serves as PwC's national tech industry expert tax, guiding clients from early-stage startups to Fortune 100 multinationals.

Chris Tran is a director in PwC's San Francisco office with over a decade of indirect tax experience. He serves as the operational lead for Bay Area consulting and compliance engagements across both emerging and mature companies.

California was one of the largest remaining states to tax SaaS. Governor Newsom signed SB 122 on June 29, 2026, and effective January 1, 2027, all prewritten software “off-the-shelf” and SaaS delivered to California customers are subject to sales and use tax, regardless of delivery method. You have four months. That sounds like a long time. It is not.

Start with the part founders miss: this tax can reach you personally

As you know, sales tax is not just another company expense; the moment you collect it from your customers, it actually belongs to the state. Because of this, state authorities can look past the corporation to hold its officers or directors personally liable and audit or collect from them if not remitted.

The other structural point: states collect on one side or the other. Either your vendor charges you sales tax, or you self-accrue and remit use tax on the same purchase. There is little room for mitigation.

What SB 122 covers

Prewritten software and SaaS, however delivered. ERP systems, CRM, productivity tools. If a customer interacts with your software to accomplish something, that is the core of what the bill captures. Custom software stays exempt.

AI usage is in scope. Selling a platform that makes models available, or access to the models themselves, will likely require collecting sales tax. Subscription, per-seat, and token-based pricing all get the same treatment if the underlying transaction is software.

Billing address drives sourcing. If your customer has a California billing address and your company hits California's $500,000 annual sales threshold in total sales, the state expects you to collect and remit tax to the state.

One threshold to know about for later. Once transactions with a single customer exceed $5 million, sales tax switches off and the burden shifts to that customer to accrue use tax. Most startups will not hit this soon, but it will complicate your billing logic when you do.

Where is the line between software and services?

This is the question that comes up most, and one company gets it wrong.

Sales and use tax uses a "true object" test. What is the customer really buying?

If the customer can use the product without interacting with a human, it is probably taxable software. The software is the product.

If a human expert delivers the value and software is just the delivery mechanism, it starts to look like a non-taxable service. A professional services firm that gives clients a portal to access deliverables is the clearest case. Remove the professional and there is no service left.

The gray zone is wide. A telehealth practitioner delivering care through a video platform sits between the two. If you cannot cleanly parse software from service in your own offering, bring in an advisor rather than guess. CDTFA is expected to publish examples to help draw the line.

Use tax is the obligation companies miss

This is the least visible piece of SB 122 and the one that generates assessments.

If a vendor does not charge you sales tax on software you use in California, you owe use tax on it. That holds regardless of which entity signed the contract or where it is based. If an out-of-state or foreign parent buys software as a shared service and your California entity uses it, California expects an allocation on a reasonable methodology, usually headcount. On a $1 million contract where 20% of relevant headcount sits in California, you report use tax on $200,000.

States typically catch this on an audit, or it might be surfaced in M&A diligence, when a buyer reviews the books and flags it as a liability.

Changing your billing address doesn't change your true tax liability. While a seller relies on your billing address to decide whether to charge sales tax, use tax is based entirely on where your California employees or operations actually use the software. If a vendor doesn't charge you sales tax, you are required to self-assess and remit California use tax based on local use.

Registration and penalties

Having a single employee in California, remote or in an office, triggers physical nexus registration with CDTFA before collecting tax. Without physical presence, the economic nexus threshold is $500,000 in gross sales of anything, and you have 30 days to remediate once you breach it. Penalties scale at roughly 5% per month and cap at 25% of the tax principal.

What exemptions are available?

Resale and manufacturing exemptions. If you buy software that you incorporate into your own product, or use as an input into what you sell, you can pull a certificate from the California website and give it to your vendor. Not to the state, to the vendor. They stop charging you, and the obligation shifts to you when you sell downstream.

Use tax direct payment permit. Unique to California and worth a look. The permit lets you skip sales tax on purchases and manage reporting in house as use tax instead, so you pay only on your California portion rather than 8% on everything. It makes the most sense for multi-state companies. Smaller companies may prefer to pay the sales tax and skip the reporting burden. The application has historically required financial statements and affidavits, though PwC expects that to be streamlined given the scope of SB 122.

Five things to do now

California SB 122 Compliance Timeline

Target: January 1, 2027

What to know about tax engines

No billing system does this natively. NetSuite, Oracle, and Coupa handle billing. Collection logic requires a dedicated engine layered on top.

The established enterprise options are Avalara and Vertex. Newer entrants like Anrok are built for SaaS and tend to price below the incumbents. If you already run billing through Stripe, TaxJar bolts onto your stack. Kintsugi is another middle-market option. Diligence these against your own billing architecture rather than taking any list as a recommendation.

Part of the work is mapping your products to the engine's tax categories, which is another reason step one comes first.

You can do this manually, but math quickly breaks down. With monthly subscription billing means 12 invoices per customer per year at 12 different rates, and sales tax files monthly, so California alone is 12 returns a year. Add New York and Texas and you are at 36.

Final Thoughts

Four months moves quickly when you are also running a company, and this is one more compliance requirement landing alongside everything else.

Start with step one. Determine whether what you sell is taxable software, a non-taxable service, or something in the gray zone. That answer drives your pricing conversations, your systems decisions, your exemption strategy, and your compliance load. Everything else waits on it.

This guide is for general information, not tax or legal advice. Consult your own advisors on your specific facts and circumstances.