Summary: Beginning Jan. 1, 2027, California and Colorado will significantly expand sales tax to many SaaS products, cloud-based applications, and electronically delivered software, marking a major shift in the taxation of digital products. This article explains what the new laws cover, key compliance considerations, and why businesses should prepare now as other states may follow suit.

The digital tax landscape just got a little stormier, and businesses that develop, license, sell, or purchase software or cloud-based solutions need to pay attention.

Beginning Jan. 1, 2027, both California and Colorado will significantly expand their sales tax treatment of digital software and cloud-based products. While the changes apply directly only to transactions in those states, their impact is likely to extend far beyond their borders. For years, California and Colorado stood among the most prominent states that generally did not impose sales tax on SaaS and electronically delivered software. Their decision to reverse course represents a significant policy shift that could influence other states as they continue searching for ways to modernize their sales tax bases and generate new revenue.

Although not as transformative as the U.S. Supreme Court’s Wayfair decision, this development could become another important milestone in the evolution of state sales taxation. Businesses with multistate operations should view these laws not as isolated state changes, but as a potential indicator of where digital taxation is headed nationwide.

Colorado Expands Sales Tax to SaaS, Cloud Software, and Digital Products

Colorado will expand its state sales and use tax base by treating most downloaded and remotely accessed computer software as taxable tangible personal property. While many Colorado home-rule jurisdictions have historically taxed software and SaaS, the state itself has generally not, creating a patchwork of tax treatment across the state.

HB 26-1223 narrows the gap at the state level, though local variation may remain, by broadening the definition of computer software to include coded instructions designed to cause a computer or other electronic device to perform a task, regardless of the method of delivery or access. As a result, taxable software now generally includes software delivered electronically, downloaded from the internet, accessed remotely through the cloud (Software-as-a-Service (SaaS)), mobile applications, and other software accessed through internet-based platforms. Although exemptions remain for custom software and negotiable license agreements, Colorado has established a high bar that excludes most standard click-through, boilerplate, and other nonnegotiable agreements.

California Broadens Sales Tax Rules for Electronically Delivered Software

California is also making a significant policy shift via SB 122, expanding its sales and use tax base to include many sales of prewritten digital software, including software delivered electronically and accessed remotely. Downloaded software, cloud-hosted applications, and both subscription and perpetual software licenses may now be taxable, while custom software development and certain professional services continue to receive favorable treatment.  Complicating matters further, the new law will require purchasers who exceed $5 million in electronically delivered or remotely accessed software purchases from a retailer annually to be liable for use tax directly to California, absolving the retailer from collection responsibility.

How Businesses Should Prepare for the 2027 Software Sales Tax Changes

Although these changes don’t take effect until 2027, implementation often takes much longer than expected.  Companies should begin evaluating:

• Whether their software, SaaS, AI-enabled products, or bundled offerings will become taxable.
• Customer contracts and licensing terms for potential exemption opportunities.
• Tax engine mappings, invoicing processes and ERP configurations.
• Product taxability matrices and exemption certificate procedures.

Addressing these items now can avoid last-minute system changes and reduce future audit risk.

More States May Follow California and Colorado’s Lead

California and Colorado are unlikely to be the last states to expand taxation of the digital economy. As legislatures continue looking for new revenue sources, we expect additional states to revisit the taxation of SaaS, AI-powered products, digital services and other cloud-based offerings. States that historically have excluded these products from taxation may now feel less pressure to maintain that competitive distinction, making similar legislation increasingly likely in the coming years.

Businesses have time to prepare, but they shouldn’t assume these changes will remain isolated. The cloud may be virtual, but sales tax exposure is becoming increasingly real. Stay tuned. The digital forecast is likely to get more active.

KSM will continue monitoring legislative developments across the country and provide timely guidance as additional states consider expanding their digital tax regimes. For more information, reach out to your KSM advisor or fill out the form below.

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