Revised California Budget Would Change Business Credit Limit, Taxation of Digital Software

Gov. Gavin Newsom recently released the May revision to his 2026-2027 budget proposal. The revision would raise revenue by about $13 billion over the next four fiscal years and includes several new tax proposals that could affect a broad range of taxpayers.

Overview

The $13.1 billion in raised revenue includes approximately $3.6 billion in fiscal 2026–2027, more than $5 billion in fiscal 2027–2028, and $4.4 billion in 2029-2030. 

Among the May proposals expected to contribute to those numbers are a permanent business credit limitation, a digital software tax, and a renewed managed care organization (MCO) tax.

Key Changes to California’s Tax Code

• MCO Tax: The original budget noted that the state’s MCO tax is inconsistent with the One Big Beautiful Bill Act, which prohibits taxes that impose higher rates on Medi-Cal plans than commercial plans or that otherwise place a disproportionate tax burden on Medi-Cal plans. To align state and federal law, the May revision would renew the existing MCO tax to support Medi-Cal programs.
• Tax Credit Limitation Made Permanent: The May revision would establish a permanent cap on business tax credits. The allowable credit would be limited to the greater of $5 million per company per year or 50% of the company’s tax liability. It has been estimated to raise $850 million in 2026-2027, growing to $1.8 billion in 2029-2030. The cap would take effect in 2027, when the current temporary credit limitation and net operating loss suspension are scheduled to expire.
  
  The limitation would not affect the refundable credit election under S.B. 175, which allows a taxpayer to make an irrevocable election on an originally and timely filed return for tax years 2024 through 2026 to receive a refundable credit equal to 20% of qualified credits exceeding the $5 million limitation. 
• Tax on Digital Software (prewritten, SaaS, cloud software): The May revision proposes applying sales tax to sales of digital prewritten software, regardless of delivery method. Software delivered by electronic transmission; local hosting; or remote access through the internet, such as Software-as-a-Service (SaaS), is included.
  
  The change would also affect technology transfer agreements because the software portion of such agreements would no longer be treated as intangible property and would therefore be subject to tax. 
  
  The Legislative Analyst’s Office has suggested extending the tax to a wider array of digital products and exempting business-to-business sales. 
  
  The sales tax has a proposed effective date of January 1, 2027, and is estimated to raise $450 million in the 2026-2027 window and $900 million in 2029-2030.