The shift to remote working has changed how businesses are providing services, and it hasn’t gone away, but it’s not in state. California’s Franchise Tax Board (FTB) takes an approach that relies on market-based sourcing, which may result in a business allocating some or all of the service income to California where the customer receives the benefit of the service, even though the consultant does the work in another state.
New guidance on how income should be allocated for purposes of market-based sourcing applies to income from tax years beginning on or after January 1, 2026, and will be particularly relevant for consultants and service providers. Look for an expert (like the best tax attorney in San Diego) who can guide you properly.
Market-Based Sourcing vs. Cost of Performance Rules
Conventionally, firms have allocated revenues according to the location of the revenue-generating activities. Most of the time, California has shifted to market-based sourcing for services instead of that.
California’s rules are that service revenues are typically allocated to the state if the benefit to the customer is obtained in California. The key issue isn’t just where staff works; it’s where the service is received.
For instance, an out-of-state expert can create a business plan for a company in California, which is to be found in Texas. Although the consultant never visits California, if the customer obtains the benefit in California, the revenue may be regarded as California-sourced.
But an out-of-state consultant working for a California customer might have to look beyond California for where the customer derives value from the work, not simply presume that all revenues would be considered California-sourced. Get in touch with professionals (like tax lien attorneys) to get out of tax debt.
The meaning of the Updated Rules for service providers
California’s new rules for the location of where a service is provided to customers are clear. Contract documents and regular course of business records may be valuable documents, but the language of the contract documents must reflect the arrangement.
If the location of a benefit cannot be determined from the available evidence, taxpayers may have to resort to reasonable approximations or to regulatory presumptions. For some professional services, such as large volume services, there are specific sourcing rules. Businesses should also be aware that revenue sourcing and the filing of the California tax return are distinct, but related questions. Filing requirements can be impacted by California connections, economic nexus standards, and the taxpayer’s legal structure.
What are the Essentials of Good Documentation of The Place of Benefit?
A well-documented strategy can assist with FTB revenue allocation.
- Write clear service contracts: outline service, business goal, customer locations, and where the service output will be utilized.
- Keep supporting records: Keep project records such as service statements, invoices, delivery records, customer communications, and documents showing the value of the service.
- Ultimate benefits: If a contractor offers service to another business for its customers, ask yourself if the service is useful to those customers as well. Rely only on an expert (like a tax resolution lawyer) who can check your issue and find a solution.
- Revenue allocation regularly reviewed: Monitor revenue by customer/by service location, review the methodology when there are changes in contracts and/or operations.
The result of the tax is not necessarily dictated by the contract language. Records should reflect the actual place of receipt of benefit.
Here are Some Tips to Minimize Cross-Border Tax Risks:
- Check out California sourcing requirements prior to taking on big out-of-state engagements.
- Use a documented and reasonable method to separate revenue from California from other revenue.
- Determine if there is any double taxation exposure in all applicable states.
- When a contract includes multiple customer locations or complex services, seek advice from a multistate tax professional.
Small and large service providers as well as remote consultants can be impacted by California’s market-based sourcing requirements. To support tax positions and mitigate the risk of unexpected assessments, businesses should be aware of where their customers are getting the benefit, know the specific language of the contract, and ensure that they keep reliable records.
