Prepared by Chase Cost Management. This brief summarizes a change in California tax law as it applies to software contracts. It is not tax advice; please confirm how it applies to your organization with your tax advisor.
Bottom Line
Starting January 1, 2027, California will charge sales and use tax on software subscriptions, including cloud-based (SaaS) software (Senate Bill 122, signed June 29, 2026). The rate is 7.25% to 11.75% depending on the location. Until now, software delivered electronically or accessed online was not taxed in California.
Whether the tax appears on your invoices depends on the billing address your suppliers have on file. Whether you owe it depends on where your users sit.
If your suppliers bill an address outside California
No California tax will appear on the invoice, but if you have users in California you owe California use tax on their share of the software and pay it on your own return. Nobody will collect it for you.
If your suppliers bill a California address
The supplier will add California tax to the entire invoice, including seats outside California, unless you give the supplier a certificate allocating the tax to your California users.
01 — How It Works
What is taxable?
Any prewritten software your organization subscribes to or downloads, whether it runs on your own servers or in the vendor's cloud. For a law firm, that covers most of the technology stack:
- Email and productivity suites
- Document and records management
- Practice management, time and billing
- Legal AI and drafting tools: likely taxable, not yet confirmed by CDTFA
- Legal operations and e-signature
- HR, finance and expense systems
- CRM and marketing platforms
- Security and IT tools
- eDiscovery hosting
Online legal research (Lexis, Westlaw, Bloomberg Law) is likely taxable: no exclusion covers it, and these platforms are sold as software with search, analytics and AI tools. Vendors may argue they sell content rather than software, and the state has not addressed it.
What is not taxable?
- Cloud computing: infrastructure where you run your own systems. The test is whether you are buying computing capacity (not taxed) or a finished application that happens to run in the cloud (taxed).
- People doing work, even if they use software to do it: IT consulting and managed services, eDiscovery managed review, court reporting.
- Implementation, training and support, when billed on their own line. If they are bundled with software on a single line, the whole line may be taxed.
- Software written only for your organization (custom code, not an off-the-shelf product that was configured).
- Software used only outside California.
- Phone and internet service is not covered by this law.
What is the rate?
7.25% statewide, plus local taxes. Combined rates run from 7.75% (Irvine, San Diego) to 10.25% (City of Los Angeles) to 11.75% (Lancaster, Palmdale). When the supplier collects, the rate is set by the billing address. When you pay use tax yourself, the rate is set by where your users sit.
Does a subscription get taxed on the whole amount if only some users are in California?
No. Only licenses used in California are taxed, and a license is used where its user sits. If 10% of users are in California, 10% of the price is taxable, at each office's local rate. You will need a defensible headcount by office, applied the same way to every vendor.
Does the supplier invoice for the tax?
Depends. The supplier charges California tax only if the billing address on file is in California. If it is outside California, no tax appears on the invoice, but you still owe use tax on your California users and must pay it yourself.
If the billing address is in California, the supplier taxes the full amount, including seats elsewhere. The fix is a multiple-points-of-use (MPU) certificate stating your California share, so the supplier taxes only that share. It is still in draft regulation, and some vendors cannot apply it, leaving you to claim a refund.
Does my existing contract get taxed?
Yes, according to the draft regulations of the California Department of Tax and Fee Administration (CDTFA). There is no exception for contracts signed before January 1, 2027, and CDTFA treats a subscription as a series of continuing sales, so service months on or after January 1, 2027 are taxable even if paid for in 2026.
Example: a contract that straddles the start date
A firm billed in New York signed a three-year Microsoft agreement on 6/1/25, billed annually, with 10% of its users in California.
| Payment | Covers | Taxable? |
|---|---|---|
| 6/1/25 | Jun 2025 to May 2026 | No |
| 6/1/26 | Jun 2026 to May 2027 | Yes, on the 10% share for the Jan to May 2027 portion (5 of 12 months), under CDTFA's draft regulations |
| 6/1/27 | Jun 2027 to May 2028 | Yes, on the 10% California share, at each California office's local rate |
Because the firm is billed in New York, Microsoft adds no California tax to any of these invoices. The firm accrues use tax on the 10% California share itself.
02 — What We Recommend
1. Bring in your tax team now
The practical question for most organizations is how to accrue and pay California use tax on California users. That is a tax-department process, and it needs to exist before January invoices arrive.
2. Keep California addresses off enterprise software accounts
If your suppliers bill your central accounts-payable address outside California, nothing is collected on the invoice and you allocate the California share yourself. A vendor account set up by a California office will be taxed in full.
3. Establish a headcount by office
It is the basis for allocating every vendor's tax, and it should be applied the same way to each one.
4. Separate software from services on renewals
Stating software fees separately from implementation, training, support and consulting can avoid unnecessary tax. CDTFA has not yet issued specific guidance on bundled charges, so this could change.
5. Check January invoices
Make sure suppliers are not adding California tax to invoices billed outside California.
6. Budget for tax on legal research
Plan for Lexis, Westlaw and Bloomberg Law to be taxed unless the vendor or the state says otherwise, and ask each vendor how it will invoice.
03 — What CCM Is Doing
- Reviewing the software contracts we manage for you and flagging the ones this tax will reach.
- Checking which address each supplier bills, and flagging any that carry a California office.
- Asking for software fees to be stated separately from services on every renewal and order form we negotiate.
- Reviewing your first 2027 invoices for California tax added in error.
04 — Status
The statute is final. CDTFA published draft emergency regulations in September 2026 and expects to adopt final emergency regulations in December 2026, with permanent rulemaking to follow in mid-2027. We will update this brief as the mechanics are settled.