California’s New Sales Sourcing Rules for Intangibles and Services: What Businesses Need to Know for 2026

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Key Takeaways

• Market-based sourcing is further clarified and expanded: California’s 2026 rules for sourcing sales of services and intangibles use a market-based approach, with new presumptions and cascading rules to determine where the benefit of a service or intangible is received.
• Four key presumptions guide benefit location: The benefit of a service is presumed to be in California if it relates to real property, tangible personal property, intangible property, or individuals in the state, but these presumptions can be overcome with sufficient evidence.
• Special rules for asset management and professional services: Asset management services are sourced based on the domicile of investors or beneficial owners, while professional services provided to more than 250 customers are sourced to customer billing addresses.
• Prospective application and compliance focus: The new rules apply to taxable years beginning on or after January 1, 2026, and require businesses to review and potentially update their documentation and sourcing methodologies.
• Increased audit and documentation requirements: Businesses must maintain robust records to substantiate the location of benefit, as the California Franchise Tax Board (FTB) may challenge unsupported sourcing positions.

Key Changes in Sourcing of Services and Intangibles

California has long used a market-based sourcing regime for sales other than tangible personal property, but the 2026 amendments to Cal. Code Regs. tit. 18, section 25136-2, introduce significant clarifications and new rules. The core principle remains: sales of services are assigned to California to the extent the customer receives the benefit in the state, and sales of intangible property are sourced to the extent the property is used in California.

The 2026 rules introduce a structured, cascading approach to determine the benefit location for services:

1. Four Presumptions: If the service predominantly relates to:
   1. Real property in California,
   1. Tangible personal property located in California when the service is received,
   1. Intangible property used in California,
   1. Individuals physically present in California at the time of service delivery, then the benefit is presumed to be in California.
2. Overcoming Presumptions: Either the taxpayer or the FTB can rebut these presumptions with a preponderance of evidence, using contracts, books and records, or other credible information.
3. Reasonable Approximation: If the benefit location cannot be determined from records or contracts, or the presumptions are overcome, the location is determined by reasonable approximation, using all available information.
4. Order Location and Billing Address: If the benefit location still cannot be determined, the customer’s billing address is used as a last resort.

For intangibles, the rules distinguish between complete transfers (e.g., sale of stock or business interests) and licenses. The sourcing is based on the use of the intangible in California, with detailed rules for different types of intangibles and fallback methods if direct information is unavailable.

Who Is Impacted by the 2026 Rule Update?

The new rules will affect a broad range of businesses, but the impact will be most significant for:

• Professional service providers: Management services, tax services, payroll and accounting services, audit and attest services, actuary services, legal services, business advisory consulting services, technology consulting services, services relating to brokering securities that generate commission income, investment advisory services other than asset management services, and services related to the underwriting of debt or equity securities.
• Asset managers and investment funds: Entities providing asset management services must now source receipts based on the domicile of investors or beneficial owners.
• Businesses with multi-state operations: Companies that sell services or intangibles to customers both inside and outside California must carefully apply the new sourcing rules to avoid double taxation or underreporting.
• Taxpayers with complex or bundled transactions: Those selling combined packages of services, tangible, and intangible property will need to analyze the principal purpose and value allocation under the new rules.

The rules apply to all taxpayers subject to California’s corporate income tax, including out-of-state businesses with California customers, and are relevant for determining California State Tax.

How Asset Management Services Are Affected

The FTB’s updated rules require asset management revenues to be sourced to the location of the investor or beneficial owner. This creates a “look-through” approach, where sourcing depends on the investors’ or beneficial owners’ locations rather than the fund itself.

To implement this, the regulations introduce a “value of interest” methodology. Mathematical formulas and examples are provided to guide taxpayers in applying the rule and ensure accurate sourcing to investors or beneficial owners.

The amendments also add new definitions for what counts as “asset management services.” These include administration, distribution, and management services.

Determining the Benefit Location: Practical Scenarios

The new rules provide a series of practical examples and cascading steps for determining where the benefit of a service is received:

• Real Property: If a service relates to real property in California (e.g., surveying, construction management), the benefit is sourced to California, regardless of where the service provider is located.
• Tangible Personal Property: If a service is performed on tangible property located in California when the service is received, or if the property is delivered to California after the service, the benefit is sourced to California.
• Intangible Property: Services related to intangibles (e.g., software development for use in California) are sourced based on where the intangible is used.
• Individuals: Services delivered to individuals physically present in California at the time of delivery are sourced to California.
• Look-Through Sourcing: For services where the benefit is ultimately received by a customer’s customer (e.g., advertising viewed by California residents), the rules allow for “look-through” sourcing, assigning receipts based on the location of the ultimate recipient.

If none of these methods yield a clear result, businesses must use reasonable approximation, and as a last resort, the customer’s billing address.

Exceptions and Special Cases Under the 2026 Rules

Several exceptions and special rules are embedded in the 2026 amendments:

• Professional Services to Large Customer Bases: If a taxpayer provides a professional service (as defined in the regulation) to more than 250 customers, receipts are sourced to the customer’s billing address, unless a single customer accounts for more than 5% of receipts from that service, in which case the standard cascading rules apply.
• U.S. Government Contracts: If the benefit location cannot be determined/disclosed for services provided to the U.S. government, receipts are assigned to California based on the ratio of California’s population to the U.S. population.
• Bundled Transactions: If a sale includes both services and property, and the value of each is readily ascertainable, each portion is sourced separately. If not, the principal purpose of the contract determines the sourcing.
• Reasonable Approximation: The FTB will accept a taxpayer’s reasonable approximation method unless it can show, by a preponderance of the evidence, that the method is not reasonable.

Action Steps for Businesses: How to Prepare

1. Review Contracts and Recordkeeping: Ensure that contracts and internal records clearly indicate where the benefit of services or intangibles is received or used. Update documentation practices as needed.
2. Assess Customer Base: Identify whether your business provides taxable services to more than 250 customers, which may trigger the billing address sourcing rule.
3. Update Accounting Systems: Modify accounting and tax reporting systems to capture the necessary data for the new sourcing rules, including customer billing addresses and benefit locations.
4. Train Staff and Advisors: Educate finance, tax, and sales teams on the new rules and the importance of accurate recordkeeping and sourcing determinations.
5. Consult with Tax Professionals: Due to the complexity of the California tax rule and the nuances involved in tax sales in California, it’s important to work with experienced advisors. They can help ensure compliance and develop reliable methodologies for reasonable approximation when necessary.
6. Monitor for Further Guidance: Stay alert for additional clarifications or guidance from the California Franchise Tax Board as the rules are implemented and interpreted in practice.

FAQs

Will these new California sourcing rules require changes to current accounting systems or software?

Yes, most businesses will need to update their accounting systems or software to track the location where the benefit of services or intangibles is received, as well as to capture customer billing addresses and other data required for compliance with the new rules.

How should businesses document the location of benefit for services to prepare for audits?

Businesses should maintain detailed contracts, customer communications, and internal records that substantiate where the benefit of each service is received. This includes tracking the physical location of property, individuals, or the use of intangibles, and retaining evidence supporting any reasonable approximation methods used.

Are there penalties for misapplying the new sourcing rules in California?

Yes, misapplying the sourcing rules can result in underpayment of tax, interest, and penalties. The FTB may challenge unsupported sourcing positions, so accurate application and documentation are essential to avoid costly disputes.

What strategies can businesses use to validate customer billing addresses under the new rules?

Businesses should regularly update and verify customer billing addresses, cross-checking with other customer data and using third-party address validation tools. For large customer bases, automated systems can help ensure accuracy and compliance.

How might California’s sourcing changes affect tax filings in other states?

California’s move to clarify market-based sourcing may create differences with states that use cost-of-performance or other sourcing methods, potentially leading to double taxation or gaps. Businesses should coordinate their multistate tax strategies and consult with professionals to manage these risks.

Conclusion:
California’s sourcing rules for services and intangibles are evolving with the implementation of the amended regulations, reflecting a significant shift in how the state apportions income. While broader federal reforms such as the One Big Beautiful Bill have influenced the overall tax landscape, these state-level changes specifically clarify presumptions, introduce new rules for asset management and professional services, and emphasize the importance of thorough documentation. Businesses should review their practices and update systems to align with the updated California sourcing rules and ensure compliance in the coming years.

Matthew Laney
Bennett Thrasher LLP
Phone: (770) 396-2200

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