In the case of businesses that focus on the cross-state, California has always been a state of confusion in terms of income apportionment jurisdiction. Traditionally, a grayish determination of whether a service was taxable in California entailed a misunderstanding of the point of service benefit.
The Franchise Tax Board (FTB) has introduced revamped Market-Based Sourcing regulations (Reg.) in the year 2026. Section 25136-2). These regulations shift to less stringent billing addresses and a more stringent Look-Through and Presumption hierarchy. These changes may have a radical impact on your tax nexus and liability, and you must notify California customers about them should your business be in the business of services or offer intangibles.
What are the new “Presumptions” for service sourcing in 2026?
The 2026 rules bring a consequence of a rebuttable presumption of series to either make sourcing of service simpler or more difficult. The FTB has adopted a rigid pecking order as opposed to a game of guesswork:
Real Property: services which are involved in real estate are assumed to be sourced to the location of the property.
Physical Goods: Sourcing of services that are provided to physical objects relates to the location of the property when the service is provided.
Intangible Property: Sourcing is based on the location of usage of the intangible property (e.g., a license or a patent) by the customer.
Individuals: When the customer is a person, the benefit will be assumed to be received where the person is present.
During this tax session, the response of the taxing session, namely the billing address, has become the default response, and that only when attempting a location of benefit is it found that the books and records are not providing such information. The role of the criminal tax attorney can help in market-based sourcing.
See also: How to Choose the Best Fence for Your Home
How does the ‘Look-Through’ rule affect asset managers?
The financial sector is among the most volatile to change in 2026. The FTB now needs a Look-Through strategy for its asset management services. Before, an asset manager would be able to originate income where they had a fund under their management.
At this point, it is necessary to look through the fund to the domicile of the underlying investors. When a fund is domiciled in Delaware but 30% of the investors are California residents, 30 percent of the management fees are California-source income. It can establish a nexus of the economy and a presence or filing requirement in California even when firms do not have any physical presence or employees in the state.
What is the “250 Customer” Safe Harbor for professional services?
The 2026 rules offer a Large Volume safe harbor, in recognition of the administrative burden on large firms. Assuming that you specialize in offering professional services (legal, accounting, consulting, etc.) to over 250 customers within a given service category, you can use the billing address of the customer as the employed sourcing method.
Nevertheless, this has a 5 percent Trap. When one customer has over 5% of the total receipts for that service, you cannot bill it to that customer; you need to use the full market-based sourcing analysis to even figure out where the customer actually benefited. The attorney for IRS issues can create a safe harbor for the working professionals.
How does ‘Reasonable Approximation’ work under audit?
In case your contracts or books do not clearly present where the benefit was given to a customer, the 2026 rules permit Reasonable Approximation. The California portion of your sales may be estimated in all justifiable ways (population data, or seat licenses, among other things).
Predictably, however, the FTB can refuse to accept your approximation in case they consider it to be unreasonable. The burden of proof on the taxpayer in this tax session is to prove their sourcing methodology with a preponderance of evidence. In the absence of strong documentation, the FTB can make up its own estimate, not normally favorable to the taxpayer.
Conclusion
The 2026 Market-Based Sourcing regulations mark the largest step that California has taken in order to increase revenues in the digital and service-driven economy. The FTB has made the way out of California taxes more challenging by adopting look-through requirements for asset managers and the imposition of strong presumptions on other service providers.
