On June 29, 2026, California Gov. Gavin Newsom approved revenue trailer legislation that expands the state’s sales and use tax base to include digital products such as electronically delivered and remotely accessed prewritten software, beginning Jan. 1, 2027.1 Senate Bill 122 also extends the state’s $5 million limitation on business tax credits through the 2029 tax year, followed by a modified permanent limitation beginning in the 2030 tax year.
Finally, the legislation temporarily reduces the annual minimum franchise tax applicable to newly formed pass-through entities from $800 to $400 during the 2027 through 2029 tax years.
Sales and use tax provisions
Effective for transactions occurring on or after Jan. 1, 2027, S.B. 122 amends the definition of tangible personal property for sales and use tax purposes to include a “digital product” and any associated copyright or patent interests.2 A “digital product” is defined as prewritten computer software transferred on tangible storage media, transferred electronically or accessed remotely.3
Certain digital goods are specifically excluded from the definition of a “digital product,” including digital assets, digital audio works, digital audiovisual works, digital books, video games and digital visual works.4 Custom computer software is not considered to be a digital product and continues to be exempt from sales and use tax.5
Specific destination sourcing rules apply to the sale of digital products.6 For example, for sales of digital products transferred electronically or accessed remotely that are not in-person sales or purchases, the place of sale or purchase is the purchaser’s known address shown in the seller’s records maintained in good faith in the ordinary course of business.7
Local and district sales and use taxes also will apply to the retail sale of digital products as defined.8 The legislation prevents any purchaser or retailer from entering into a local tax revenue-sharing agreement with a local agency for taxable purchases or sales of digital products that are transferred electronically or accessed remotely.9
A retailer is relieved from liability to pay sales tax or collect use tax on the sale of an electronically transferred or remotely accessed digital product if gross receipts from the sale of such products exceed $5 million in the aggregate in the current calendar year, or beginning Jan. 1, 2028, in the current or preceding calendar year.10 In this case, the purchaser becomes liable for use tax on the transaction that caused the retailer to exceed the $5 million threshold.11
The purchaser is required to self-assess use tax and pay the tax due to the California Department of Tax and Fee Administration (CDTFA).12 The $5 million threshold is subject to adjustment every five years in accordance with the percentage increase in the California Consumer Price Index.13
The legislation provides for an exemption from sales and use tax on sales of digital products purchased solely for use outside the state or in interstate or foreign commerce.14 The burden of proving the exemption is on the seller of the digital product, unless the purchaser provides an exemption certificate certifying that the property is purchased solely for use outside the state, or in interstate or foreign commerce.15
The CDTFA is responsible for prescribing the forms and exemption certificates necessary to implement the exemption.16 Similarly, a credit is permitted for retail sales tax paid to another state or political subdivision on the retail sale of electronically transferred or remotely accessed digital products.17
Extension of business tax credit limitation
Previously, the use of business tax credits for corporate and personal income tax purposes was limited to $5 million per tax year for the 2024-2026 tax years.18 The $5 million limitation that can be applied to reduce the net tax applies on a combined group basis such that the aggregate annual net tax of all members of the combined group cannot be reduced by more than $5 million.19
S.B. 122 extends the $5 million business tax credit limitation through the 2029 tax year.20 The carryforward period for unused credits resulting from the limitation remains extended by an additional year for each year the limitation impacts the utilization of the credit. Likewise, the period for making an irrevocable election to receive an annual refundable credit amount (equal to 20% of the qualified credits that would have otherwise been available) is extended through the 2029 tax year.21
Beginning with the 2030 tax year, the business tax credit limitation is modified to equal the greater of 70% of total net taxes imposed or $5 million per tax year, with a narrow exclusion for certain business tax credits.22 The modified limitation would apply on a permanent basis. Any annual refundable credit amount included in the irrevocable election is not included in the $5 million limitation for the 2027-2029 tax years.23
Corporate income tax credits affected by the limitation include the research and development credit, the jobs tax credit, the California Competes credit and the motion picture production credits. Various personal income tax credits are excluded from the limitation, including the pass-through entity (PTE) tax credit, earned income tax credit and renter’s tax credit.24
Temporary minimum Franchise tax reduction for new pass-through entities
Currently, California imposes an annual minimum franchise tax of $800 on every limited partnership, limited liability partnership and limited liability company doing business in the state. Effective for the 2027-2029 tax years, the annual minimum franchise tax is reduced to $400 during such entities’ first year of operations.25
Commentary
California’s revenue trailer legislation follows the state’s $352 billion budget legislation that was enacted in early June and contains various tax changes necessary to implement the legislation. With the revenue trailer bill, California becomes the latest state to extend its sales and use tax base to include certain types of electronically delivered and remotely accessed software (potentially including software as a service (SaaS)). According to a Senate analysis, the sales and use tax expansion is expected to increase General Fund revenues by $450 million during the 2027 fiscal year and $900 million annually on a prospective basis.26
As California has long excluded the sale of prewritten software from sales and use tax, proponents of the legislation supported expanding the sales tax base to modernize the state’s sales tax system and address revenue shortfalls, while business groups have argued that the new tax on software would function as a tax on business inputs without a corresponding exemption for software purchases by businesses.
In any event, the taxation of prewritten software in California presents a significant change for technology companies doing business in the state. Impacted businesses will want to evaluate their product and service offerings to determine whether they now meet the definition of a taxable digital product under the law change. Retailers of digital products will be required to update their sales tax compliance collection and remittance processes beginning Jan. 1, 2027, and may also review their contracting and invoicing policies governing whether they may seek reimbursement of sales tax from their customers.27
Purchasers will likewise need to evaluate use tax accrual processes for purposes of self-assessing use tax on purchases of digital products where appropriate. The CDTFA is also expected to issue guidance speaking to further definitions, sourcing rules, the multiple points of use exemption, and other mechanics of the statutory changes.
Importantly, S.B. 122 extends the three-year $5 million limitation on the annual use of business tax credits for another three years from 2027 through 2029, in addition to the option to claim a refundable credit for the amount of credits a business is unable to use during that period. The refundable credit is paid at a rate of 20% of the unused credit balance over five years.
A permanent limitation is established in 2030, giving businesses the option to use their credits equal to the greater of $5 million or 70% of their liability. With the introduction of a permanent credit limitation, taxpayers will want to evaluate the value and use of their existing business tax credits on a prospective basis.
1 Ch. 23 (S.B. 122), Laws 2026.
2 S.B. 122, § 9, amending CAL. REV. & TAX. CODE § 6016(a).
3 S.B. 122, § 10, adding CAL. REV. & TAX. CODE § 6016.1(a).
4 S.B. 122, § 10, adding CAL. REV. & TAX. CODE § 6016.1(b), (c).
5 S.B. 122, § 8, amending CAL. REV. & TAX. CODE § 6010.9(a).
6 S.B. 122, § 6, amending CAL. REV. & TAX. CODE § 6010.5.
7 S.B. 122, § 6, adding CAL. REV. & TAX. CODE § 6010.5(b)(3)(A). A hierarchy of known addresses is followed if more than one address is provided to the seller during the consummation of the sale or purchase: (i) the purchaser’s billing address; (ii) the purchaser’s shipping or delivery address; (iii) the mailing address associated with the purchaser’s payment instrument; and (iv) the purchaser’s mailing address. S.B. 122, § 6, adding CAL. REV. & TAX. CODE § 6010.5.(b)(3)(B), (C).
8 S.B. 122, § 1, amending CAL. GOV’T. CODE § 53084.5.(d).
9 S.B. 122, § 1, amending CAL. GOV’T. CODE § 53084.5.(c)(1).
10 S.B. 122, § 12, adding CAL. REV. & TAX. CODE § 6052(a); § 14, adding CAL. REV. & TAX. CODE § 6201.55(a).
11 S.B. 122, § 12, adding CAL. REV. & TAX. CODE § 6052(a)(1)(B).
12 S.B. 122, § 12, adding CAL. REV. & TAX. CODE § 6052(b).
13 S.B. 122, § 12, adding CAL. REV. & TAX. CODE § 6052(a)(2)(A).
14 S.B. 122, § 26, adding CAL. REV. & TAX. CODE § 6372(a).
15 S.B. 122, § 26, adding CAL. REV. & TAX. CODE § 6372(b).
16 S.B. 122, § 26, adding CAL. REV. & TAX. CODE § 6372(e).
17 S.B. 122, § 18, amending CAL. REV. & TAX. CODE § 6406.
18 CAL. REV. & TAX. CODE § 17039.4.
19 Id.
20 S.B. 122, § 22, amending CAL. REV. & TAX. CODE § 17039.4.(a).
21 S.B. 122, § 23, amending CAL. REV. & TAX. CODE § 17039.5.
22 S.B. 122, § 24, adding CAL. REV. & TAX. CODE § 17039.6.
23 S.B. 122, § 24, adding CAL. REV. & TAX. CODE § 17039.6.(e).
24 S.B. 122, § 22, amending CAL.REV. & TAX. CODE § 17039.4.
25 S.B. 122, § 25, adding CAL. REV. & TAX. CODE § 17935(f)(2); § 26, adding CAL. REV. & TAX. CODE § 17941(g)(2); § 27, adding CAL. REV. & TAX. CODE § 17948(e)(2).
26 Cal. S.B. 122 Senate Floor Analysis, Committee on Budget and Fiscal Review, June 17, 2026.
27 California regulations provide that whether a retailer may add sales tax reimbursement to the sales price of tangible personal property sold at retail to a purchaser depends upon the terms of the agreement of sale. CAL. CODE REGS. tit. 18, § 1700(a)(1).
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