California’s tax on software subscriptions leads $14.3 billion in new levies, taxpayer group says

A California Tax Foundation tally finds that Gov. Gavin Newsom and the Legislature approved 67 tax and fee increases over the two-year session, led by a law that extends the sales tax to downloaded and cloud-based software beginning Jan. 1.

By Staff Reporter

SACRAMENTO — In 10 weeks, Californians who buy a software subscription will begin paying sales tax on it for the first time. That change, enacted in June as part of the state budget, is the largest piece of what a new report describes as $14.3 billion a year in tax and fee increases approved by the Legislature and Gov. Gavin Newsom during the 2025-26 session.

The report, published by the California Tax Foundation, the research affiliate of the California Taxpayers Association, catalogs 156 proposals to raise taxes or fees that lawmakers considered over the two years, with a combined price of more than $803 billion if all had become law. Sixty-seven were passed and signed.

“When the new taxes and fees approved this session are fully implemented, Californians will be paying $14.3 billion more to their state and local governments, on top of any additional taxes approved in the November election,” Caitlin Herring, a research analyst at the foundation, said in a statement accompanying the report. “These new expenses will increase the cost of living in this state just as a new governor takes office and begins grappling with California’s ongoing affordability problem.”

The tally circulated widely online over the weekend, two weeks before voters choose Mr. Newsom’s successor.

A tax on code, not just discs

The largest single item is SB 122, a budget bill Mr. Newsom signed on June 29. It does two things. It redefines “tangible personal property” in the sales tax law to include prewritten computer software, however it is delivered: on a disc, by download or accessed remotely as software-as-a-service. And it permanently caps how much of their tax bills companies may wipe out with business tax credits, at the greater of $5 million a year or 70 percent of liability, according to the foundation’s summary.

The foundation puts the combined cost of those two provisions at $9.17 billion a year, citing estimates from the Silicon Valley Tax Directors Group and the Legislative Analyst’s Office. The administration’s own projections, made when Mr. Newsom proposed the ideas in his May budget revision, were smaller: about $900 million a year for the state’s general fund and $1.1 billion for local governments from the software tax once fully in effect, and about $1.7 billion a year from a credit limit that, as first proposed, was set at 50 percent of liability. The report does not reconcile the two sets of figures.

The second-largest item, at $2.3 billion a year by a Department of Finance estimate cited in the report, is a tax on managed care health plans enacted through a companion budget bill, SB 125.

Until now, California taxed software only when it arrived on a physical medium, a distinction the Legislative Analyst’s Office called “very difficult to justify.” In May, the administration said that 35 of the 45 states with a statewide sales tax already taxed downloaded software and that 24 taxed software-as-a-service, and it presented the change as a step toward “restoring the state’s structural balance.”

The analyst’s office found the administration’s revenue estimates “reasonable” and saw merit in modernizing a sales tax built for an economy of physical goods. But it cautioned that a large share of the newly taxed sales would be between businesses, and that such taxes “can raise costs for consumers even more than a direct tax on consumption” because companies often pass them along. It recommended exempting or reducing the rate on software bought by businesses, as Connecticut, Iowa, Maryland and New Jersey do; the exemptions in the enacted law include no such provision.

What changes on Jan. 1

The California Department of Tax and Fee Administration has issued a special notice and a tax guide telling software sellers that they may need to register for a seller’s permit and begin collecting tax. Cryptocurrency, music, movies, e-books, video games and cloud infrastructure that customers use to run their own applications are excluded. Custom software and software bought solely for use outside California are exempt.

The law also departs from the usual rule that sellers collect the tax. Once a business buys more than $5 million a year in electronically delivered or remotely accessed software from a single vendor, the liability may shift to the buyer, which must then obtain a direct payment permit and pay the tax itself. The department has circulated draft emergency regulations, which the law lets it adopt without the standard comment period. The drafts, still subject to revision, say that a license paid for in December but usable only from Jan. 1 would be taxable.

The Bay Area stake

The change lands heavily in the Bay Area, home to some of the largest sellers of subscription software, including Salesforce in San Francisco and Workday in Pleasanton. Because the department generally treats the customer’s address as the place of sale for software delivered online, local sales tax revenue from the new tax will flow to the cities and counties where buyers are located.

The report also counts measures that take effect only if voters approve them, among them SB 63, by State Senator Scott Wiener of San Francisco, which allowed a regional transportation district to place a 1 percent sales tax in San Francisco and half-cent taxes in Alameda, Contra Costa and Santa Clara counties on the Nov. 3 ballot, according to the foundation’s summary. The foundation, drawing on the ballot language, values that measure at $980 million a year. Statewide propositions such as the Proposition 40 wealth tax are excluded because they required no legislative action.

For software buyers, the practical question is narrower. Starting Jan. 1, the price of many subscriptions in California will carry a sales tax line, and the state’s final rules on how to apply it are still being written.