What California’s New Software Tax Really Means for Local Government

I was sitting in another riveting budget meeting, the kind where we go around the table looking for things to cut from next year’s projected budget. The reason for the exercise this time was California state Senate Bill 122. It wasn’t the first time I’d heard its name invoked like a minor curse word. I tried to find something interesting to stare at (the wall was conveniently blocked by a drop-down projector screen showing a pixelated spreadsheet), and as we went round robin on which line items might get sacrificed, like a table of stakeholders trying to agree on toppings for the world’s most complicated combination pizza, nobody willing to give up their own slice, I started thinking about what SB 122 actually does, and what it will really mean for public agencies once the dust settles.

Everyone in that room had an opinion about it. Almost nobody had read past the trailer-bill summary. So I did. Here’s what I found, and why it matters well beyond California.

THE LOOPHOLE CALIFORNIA FINALLY CLOSED

California SB 122, a state budget trailer bill, was signed into law by Gov. Gavin Newsom on June 29, 2026. It closes a gap that’s existed in California’s Sales and Use Tax Law since long before SaaS existed: software delivered electronically or accessed remotely has never been taxable in the state, because it involves no transfer of “tangible personal property.” Software on a CD was taxable. The identical product delivered as a cloud subscription was not. It made sense in 1955. It’s made increasingly little sense every year since.

SB 122 fixes that, but not yet. The bill is law now, and the tax itself doesn’t become operative until Jan. 1, 2027. Nothing changes for agency budgets between now and then. Once it does, “tangible personal property” will include prewritten software delivered on physical media, downloaded or accessed remotely, and the state’s 7.25 percent base sales tax rate, plus local add-ons, will apply to most commercial and government software purchases.

Sitting in that meeting, the question that mattered wasn’t the mechanics. It was whether local government ever sees a dime of this, or whether the state is just taking more off the top while we cut positions to cover renewals. The honest answer is that it’s two different budgets telling two different stories.

WHY THE STATE'S OWN NUMBERS SAY LOCAL REVENUE GROWS

Here’s what surprised me: This isn’t a state clawback. California’s local sales tax law is built so that when the Legislature expands what’s taxable at the state level, that expansion automatically flows into local sales tax revenue too — no city council vote or county ordinance required. The state’s own budget projections estimate local sales tax revenue will grow roughly $560 million statewide in year one, climbing toward $1.1 billion annually after that, purely as a byproduct of software joining the taxable base.

That’s a real number, and it’s worth sitting with. Local government as a sector isn’t losing money to Sacramento here. It’s gaining from a broader tax base, automatically and without state administrative action.

WHY THAT DIDN'T MAKE THE BUDGET MEETING ANY LESS PAINFUL

That statewide number and my department’s budget line are not the same thing, and conflating them is exactly what made that meeting go sideways.

Local governments aren’t just tax collectors here. They’re also major buyers of the same software this law now taxes. California doesn’t exempt public agencies from sales tax on their own purchases. So starting in 2027, every case management system, permitting platform, cybersecurity tool and HR system a city or county renews costs 7-plus percent more, landing directly on the department managing the contract the moment the invoice arrives.

The statewide revenue gain, meanwhile, is general fund money, driven mostly by private businesses and consumers buying software that has nothing to do with any given department’s own procurement. It’s collected by the county’s tax administration function and run through the ordinary budget process, with no mechanism in the law that routes any of it back to departments now paying more for their own tools. The cost increase is certain and immediate. The offset, if it comes at all, depends on a budget decision nobody is obligated to make.

That gap is worth naming clearly, because “this will hurt our budget” and “the state projects local revenue growth” are both true. They’re just describing different budgets.

WHAT PUBLIC-SECTOR IT AND FINANCE TEAMS SHOULD DO NOW

A few things worth doing well before January 2027:

• Inventory every prewritten software contract (on-premises, downloaded or cloud) and flag renewals landing on or after Jan. 1, 2027.
• Watch how vendors classify their products. Custom development and pure services generally stay untaxed; a configurable SaaS platform usually won’t.
• Build the added cost into FY 2027-2028 projections now, especially for multiyear contracts signed today that renew after the effective date.
• Raise the offset question with your finance office before renewal season, not during it. If departments are going to be held harmless for this cost, that has to be a deliberate budget decision. It won’t happen by default.

Other states are watching California close this loophole, and several are likely to follow. Whenever they do, the same disconnect will show up in budget meetings everywhere: state and local government, in aggregate, gaining tax revenue, while the departments actually running the technology absorb a direct cost increase with no built-in way to get any of that revenue back.

I plan to raise that distinction at my next budget meeting, projector screen and all. Wish me luck.

Kelven Leverett works in Governance, Risk and Compliance for Placer County, where he focuses on regulatory compliance, vendor risk management and security program development. He holds the CISSP, CISM, and CISA certifications and serves as an officer on the ISACA Sacramento Chapter's Board of Directors.