California lawmakers have advanced a budget trailer bill that expands the state’s sales tax to include digital prewritten software and Software-as-a-Service while tightening limits on business tax credits. The measure, embedded in SB/AB 122, cleared the Assembly on June 15 and is expected to move to the Senate for concurrence on June 18.
The legislation would apply California’s sales and use tax to digital prewritten software and SaaS, a category previously exempt.
Regulators would have two years of emergency authority to clarify operational details, including the definition of a “digital product.” The proposal leaves unanswered how to distinguish custom software from prewritten software and how bundled transactions would be treated.
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A separate provision restricts business tax credits, raising the overall tax burden for some companies. The bill replaces the governor’s original plan for an immediate cap with a phased approach. For 2027 through 2029, the existing $5 million limit on business credits stays in place. In 2030, the cap becomes permanent, set at the greater of $5 million or 70% of a taxpayer’s liability.
This structure is less restrictive than the May revision’s 50% cap but still marks a departure from the current temporary system. Companies with large credit balances, particularly in research and development, may face higher effective tax rates. The proposal does not alter net operating losses or the 2024 budget deal on refundable tax credits.
Tax professionals warn the combined effect of the new sales tax and credit limits could have procurement, compliance, and income tax planning consequences for businesses operating in California. The bill’s passage appears likely due to the reported consensus, though minor adjustments may still occur.
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If enacted, the changes would rank among the most significant expansions of California’s tax base in years. The CDTFA’s regulations will determine how the rules are applied in practice. Businesses relying on software and SaaS across sectors should prepare for potential shifts in tax planning and compliance.
Similar debates over taxing digital services have emerged in other states, often raising concerns about fairness and administrative complexity. A recent standards test highlighted how regulatory ambiguity can undermine policy goals.
