New California Law Creates an Additional Tax Layer for UCaaS, Cloud Communications and Other Telecom/SaaS Bundles
California has fundamentally changed the tax treatment of Software-as-a-Service (“SaaS”)—and communications providers that bundle telecommunications with software should be paying especially close attention.
Governor Gavin Newsom recently signed
Senate Bill 122 (“SB 122”), which significantly expands California’s sales and use tax base to include certain “digital products.” Beginning January 1, 2027, California will treat prewritten computer software as taxable regardless of whether it is delivered on physical media, downloaded electronically, or—as is increasingly common—accessed remotely as SaaS.
For traditional software companies, the message is relatively straightforward: a product that historically escaped California sales tax because customers accessed it through the cloud may soon become taxable.
For UCaaS, CCaaS, CPaaS, hosted voice, managed communications and other providers that combine telecommunications with SaaS, however, the implications are considerably more complicated.
The Rules Are Changing for the “Non-Telecom” Side of the Bundle
For years, many communications providers have appropriately divided bundled offerings between regulated telecommunications services and non-regulated software, SaaS and other components.
Those allocations matter because the telecommunications portion of a bundled service can carry an extraordinary assortment of federal, state and local regulatory fees, surcharges and telecommunications taxes. In California, depending on the service and jurisdiction, that can include CPUC regulatory fees and applicable local Utility Users Taxes (“UUTs”), among other obligations.
The SaaS component, by contrast, has generally not been subject to California sales and use tax merely because the software was electronically delivered or remotely accessed.
Beginning January 1, 2027, that equation changes.
SB 122 expands the definition of taxable tangible personal property to include a “digital product,” which the statute defines to include prewritten computer software transferred electronically or accessed remotely. The statute expressly reaches the type of remotely hosted software functionality that lies at the heart of many modern cloud communications offerings.
Put differently: If your company sells telecommunications bundled with SaaS, and you have historically allocated a portion of the bundled charge to telecommunications—subjecting that portion to CPUC fees, applicable local UUT and other telecommunications taxes and surcharges—while treating the SaaS portion as outside California sales tax, you need to revisit that model now.
Starting January 1, the telecommunications allocation may continue to carry its applicable telecommunications-specific taxes and regulatory fees, while the SaaS allocation may separately become subject to California state and local sales and use tax.
The allocation may still be critically important. But rather than separating a “taxed” telecommunications component from an “untaxed” SaaS component, providers increasingly may be determining which tax and fee regime applies to each component of the offering.
A Simple Example
Consider a cloud communications provider that sells a $100 monthly UCaaS package and, following a supportable allocation methodology, attributes:
-
$30 to interconnected VoIP or other telecommunications functionality; and
-
$70 to SaaS, collaboration, administrative or other software functionality.
Historically, the $30 telecommunications component might have been subjected to the applicable telecommunications taxes, regulatory fees and surcharges, while the $70 SaaS component generally was not subject to California sales tax simply because customers accessed the software remotely.
Effective January 1, 2027, that $70 software component may itself become subject to California sales and use tax if it constitutes taxable prewritten software under SB 122 and no exclusion or exemption applies.
That does not mean every dollar of every cloud communications offering automatically becomes taxable. Classification, bundling, allocation, sourcing, customer location, contractual structure and the precise functionality being supplied all matter.
But it does mean that providers should not assume their existing California tax configuration will remain correct in 2027.
What Exactly Does SB 122 Tax?
SB 122 reaches broadly defined prewritten software, including software that customers access remotely by password, digital code or other means while the software resides on the vendor’s—or a third party’s—server.
The law also contains important exclusions and exemptions. Among other things:
-
Custom computer software prepared to the special order of a single customer remains outside the general taxable definition, although prewritten software does not become “custom” simply because it is configurable or was originally developed for a particular customer.
-
Certain digital infrastructure services are excluded, including qualifying cloud-based infrastructure that permits a customer to create, deploy, scale or run the customer’s own software.
-
Certain electronically delivered services primarily involving human effort performed after the customer requests the service may qualify for an exemption, although the statute expressly limits that exemption where the customer is obtaining the right to use or access the provider’s cloud-hosted software.
-
The statute provides rules for digital products purchased solely for use outside California or in interstate or foreign commerce.
These distinctions make product classification increasingly important. Labels such as “UCaaS,” “platform,” “managed service,” “software,” “support” or “technology fee” do not necessarily determine the tax result. What the customer actually receives—and how the provider structures, contracts for, prices, allocates and invoices it—can matter considerably.
Sourcing Matters Too
SB 122 also creates specific sourcing rules for electronically delivered and remotely accessed digital products.
For most non-in-person transactions, the law initially looks to the purchaser’s California address contained in the seller’s records, using a statutory hierarchy that generally begins with the billing address, followed by other customer address information. The statute separately provides that the place of actual “use” of remotely accessed software is where the person accessing the software is located.
That distinction can become particularly significant for enterprise customers with users in multiple jurisdictions.
The law also establishes special rules for very large transactions. When purchases of covered digital products from a particular retailer to a particular purchaser exceed $5 million, responsibility for reporting and remitting the tax can shift to the purchaser, subject to the statute’s requirements and CDTFA procedures.
Bundled Offerings Deserve Immediate Attention
For the communications industry, perhaps the most important unresolved issue is how California ultimately applies the new rules to complex bundled offerings.
A modern cloud communications service may combine:
-
regulated telecommunications;
-
interconnected VoIP;
-
messaging;
-
conferencing;
-
collaboration tools;
-
contact-center functionality;
-
artificial intelligence features;
-
analytics;
-
administrative portals;
-
software licenses;
-
implementation and configuration;
-
support; and
-
other managed or professional services.
Those components do not necessarily receive identical regulatory or tax treatment.
The California Department of Tax and Fee Administration (“CDTFA”) has begun the implementation process, but significant questions remain concerning bundled transactions, multi-jurisdictional use, contract transitions, classification and other implementation details. Additional regulations and guidance are expected before the January 1, 2027 effective date.
For communications providers, this makes the remainder of 2026 an important planning window.
What Providers Should Be Doing Now
Companies selling SaaS, cloud communications or bundled telecommunications/software offerings into California should consider reviewing:
-
Product and Service Catalogs. Identify precisely what is being sold and which components potentially constitute taxable prewritten software.
-
Existing Telecom/SaaS Allocations. Determine whether current allocation methodologies remain supportable and how the new sales-tax treatment changes the economic consequences of those allocations.
-
Contracts and Order Forms. Review tax pass-through language and determine whether agreements allow newly applicable sales and use taxes to be charged to customers.
-
Invoices and Billing Architecture. Confirm that billing systems can separately identify telecommunications, SaaS and other components and apply different tax treatments where appropriate.
-
Tax-Engine Mapping. Providers using platforms such as Avalara, CereTax, SureTax or similar systems should review product mapping, tax codes, sourcing data and effective dates before January 1.
-
Customer Location Data. Evaluate whether the information being captured is sufficient to apply California’s new sourcing rules, particularly for multi-location enterprise customers.
-
Exemptions and Exclusions. Determine whether any portions of an offering constitute custom software, qualifying digital infrastructure, human-effort services, out-of-state use or another excluded or exempt transaction.
-
Pricing and Margin Impact. Consider whether the new tax will be passed through to customers, absorbed, or require changes to product pricing and packaging.
The Bottom Line for Communications Providers
California’s new SaaS tax does not eliminate the need to distinguish telecommunications from software.
It makes getting that distinction right even more important.
Telecommunications and SaaS may now sit in different—but overlapping—tax and regulatory regimes, and an allocation that was developed several years ago may produce materially different consequences beginning January 1, 2027.
For providers selling UCaaS, CCaaS, CPaaS, VoIP, cloud communications or other hybrid technology offerings, this is therefore not simply a “software tax” issue.
It is a communications tax, regulatory fee, product-classification, allocation, billing and tax-engine implementation issue.
CommLaw Group Can Help
Our attorneys regularly work with communications providers to analyze bundled offerings, develop and defend allocation methodologies, classify products and services, review federal, state and local tax and regulatory fee obligations, and translate those conclusions into workable billing and tax-engine configurations.
And for companies already using a telecom/SaaS allocation in California, the message is especially important: If you sell telecommunications bundled with SaaS, have allocated a portion of the customer charge to telecommunications, and are already accounting for CPUC regulatory fees and applicable local Utility Users Taxes on the telecom component, you may soon have another tax to address on the SaaS component.
January 1, 2027 is approaching. Now is the time to determine how SB 122 will affect your products, pricing, contracts, billing systems and customers—not after the first invoices of 2027 go out.
Contact us. We’re standing by to help you understand how and when California’s new SaaS tax will impact your business—and what you should be doing about it now.
This Client Advisory is provided for informational and educational purposes only and does not constitute legal or tax advice. Application of California sales and use tax, telecommunications taxes, regulatory fees and local Utility Users Taxes depends upon the particular facts, services and jurisdictions involved. Companies should consult experienced counsel regarding their specific circumstances. This material may constitute attorney advertising in certain jurisdictions.