INSIGHT

California 2026–2027 Budget Bill Expands Sales Tax to Software and Permanently Limits Business Credits 

Dilyana Antevil, Yung Ling • July 15, 2026

Services: Tax

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California has enacted its 2026–2027 budget legislation, which includes two tax changes that could significantly affect businesses operating in the state. Beginning January 1, 2027, California will expand its sales and use tax base to include certain digital products, including prewritten software and software-as-a-service (SaaS). The legislation also revises the state’s business tax credit limitation provisions, creating planning considerations for companies with significant California credit carry forwards. 

Key Changes to California’s Tax Code 

Sales and Use Tax on Prewritten Software and SaaS 

Effective January 1, 2027, California will treat certain digital products as taxable tangible personal property for sales and use tax purposes. The new rules apply to prewritten software whether it is transferred via tangible media, delivered electronically, or accessed remotely, including SaaS. Custom software remains outside the scope of the expanded tax base, making the distinction between prewritten and custom software increasingly important for both sellers and purchasers. 

The legislation excludes several categories from the definition of taxable digital products, including digital assets, audio and audiovisual works, books, video games, and certain remotely provided digital infrastructure that allows users to run their own software. 

California expects the software and SaaS provisions to generate significant new revenue, with estimates increasing over the first several years after implementation. 

Sourcing, exemptions, and purchaser obligations. The bill includes several provisions that will affect how taxpayers implement the new tax law in practice: 

• For certain large or high-volume transactions, including a single transaction exceeding $5 million or aggregate transactions exceeding $2.5 million in the prior or current year, retailers may be relieved of the obligation to collect and remit sales tax on electronically delivered or remotely accessed prewritten software, shifting the obligation to self-assess and remit use tax to the purchaser. 
• Purchasers may need to allocate the tax base based on where taxable digital products are used or where SaaS is consumed. 
• An exemption may apply to digital products purchased solely for use outside California or in interstate commerce, although the exemption does not extend to products delivered via tangible storage media. 
• A separate exemption applies to certain digital products that represent a personal or professional service; however, that exemption does not apply to SaaS. 
• The bill also provides relief intended to reduce double taxation where sales tax has already been imposed on the same digital product by another jurisdiction. 

Actions to consider. Businesses that buy or sell software in California should consider taking the following steps before the January 1, 2027, effective date: 

• Itemize software, SaaS, and other digital offerings to determine which products may be taxable. 
• Review billing systems to confirm whether they can distinguish taxable and nontaxable software transactions. 
• Evaluate procurement and accrual processes to determine whether taxable purchases can be identified and use tax can be self-assessed when required. 
• Assess whether exemptions may apply for software or digital products used outside California or in interstate commerce. 
• Consider how the tax may affect pricing, contract language, invoicing, and customer communications for transactions occurring on or after January 1, 2027. 
• Monitor future guidance from California tax authorities on definitions, sourcing, exemptions, resale treatment, bundling, and documentation requirements. 

Permanent Business Tax Credit Limitation 

The budget legislation also revises California’s business tax credit limitation provisions for tax years beginning on or after January 1, 2027. Under the new framework, credit utilization will be permanently limited based on a statutory threshold of $5 million or 50% of the taxpayer’s California income or franchise tax liability. This change follows several years of temporary California limitations on net operating losses and business tax credits. Under current law, California suspended NOL deductions for certain taxpayers and limited business tax credit utilization during the 2024 through 2026 tax years, subject to exceptions and carryover relief for affected attributes. 

Beginning in 2027, the NOL suspension is expected to be sunset, while the credit limitation has been made permanent. Companies with significant California credit carryforwards should model how the revised limitation may affect cash tax liabilities, credit utilization timing, and the value of prior business credit elections. Taxpayers should also monitor future administrative guidance, as certain mechanical questions may need additional clarification. 

BPM Insight 

• Businesses that buy or sell software in California should begin assessing exposure now. Product classification will be a threshold issue because it drives taxability, billing, contracting, and compliance. 
• Sellers should evaluate whether their systems can apply tax correctly across delivery models, while purchasers should review whether procurement and accrual processes can identify taxable purchases and support use tax self-assessment when vendors do not collect tax. 
• Companies with significant California credit carryforwards should revisit their cash tax forecasts and credit utilization models considering the revised limitation rules. 
• Multistate purchasers should carefully track tax paid to other jurisdictions and maintain documentation to support any available relief from double taxation. 
• Because key implementation issues may require further clarification, taxpayers should monitor guidance from California tax agencies and consult with their tax advisors before finalizing systems, contracting, and reporting changes. 

Please contact your BPM tax advisor to discuss how these changes may affect your business and what steps may be appropriate before the January 1, 2027, effective date.