ARTICLE | October 24, 2025

At Larson Gross, we help clients navigate the complex intersection of tax law, business operations, and strategy—especially when those changes impact where and how income gets taxed. One such change is now official: California has formally adopted amendments to its market-based sourcing rules, and these will affect how service providers allocate revenue to California starting in tax years beginning on or after January 1, 2026. Whether you’re a professional services firm, asset manager, or a business offering digital or consulting services across state lines, these updates could significantly impact your California apportionment—and ultimately, your tax liability. Here’s what changed, why it matters, and what actions we recommend for your business.

Whats’ Changed – And Why It Matters

1. Refined “Benefit of Service” Framework

What Changed:
California’s core sourcing principle remains: income from services is sourced to where the customer receives the benefit of the service. But now, the amended rules introduce presumptions based on the type of service and the nature of the property or recipient involved.

Why It Matters:
This gives businesses a clearer roadmap. You’ll be required to assess not where the work is performed—but where the customer actually benefits. If you’re not already tracking that information, it’s time to start.

For example:

• If you service California-located real or tangible property → receipts are sourced to CA.
• If you provide services directly to individuals → source to where they are physically located when the service is received.

2. New Rules for Professional Services with 250+ Customers

What Changed:
If you provide a single type of professional service to more than 250 customers, your receipts from that service are now sourced based on customer billing address, unless a customer makes up more than 5% of those receipts.

Why It Matters:
This creates a simplified rule for large-volume service providers—like tax firms, consultants, attorneys, and IT providers. If your client base is mostly outside California, this could reduce your California-sourced revenue.

3. Asset Management Industry: Look-Through to Investor Location

What Changed:
Asset managers must now source revenue based on the average value of each investor’s interest in an investment vehicle—and tie that back to the investor’s domicile.

Why It Matters:
This creates a direct link between California-based investors and the sourcing of revenue to California. If you manage investment funds or pooled assets, you may see a sharp increase in California-sourced income—even if your fund is organized or managed elsewhere.

4. Expanded Rules for Intangibles, TPP, and Real Property Services

What Changed:
There are now more specific sourcing presumptions based on whether services relate to real property, tangible property, or intangible assets.

Why It Matters:
This removes ambiguity. It also puts the burden on taxpayers to align their service categorization and sourcing logic. For example:

• Maintenance services for equipment used in California? Source to California.
• Licensing software used by a California company? Source to California.

5. New Guidance for Federal Government Contracts

What Changed:
If your customer is the U.S. government and you can’t disclose or determine the location of benefit, you must source revenue based on California’s share of the U.S. population.

Why It Matters:
This could increase California apportionment for businesses with classified or nationwide government contracts. Even if the federal agency is not located in California, part of that revenue may now be pulled into the state.

6. Flexibility with Reasonable Approximation Methods

What Changed:
If no specific benefit location can be determined, California now allows the use of reasonable approximation methods—but you must document your rationale and use consistent methodology.

Why It Matters:
This gives businesses more flexibility but also raises the bar on documentation. California may challenge methods that lack support or appear self-serving.

Who’s Most Affected?

You should pay close attention if you:

– Provide professional services to 250+ clients
– Manage funds or pooled assets with CA-based investors
– Have complex consulting or licensing arrangements tied to CA-based property
– Serve federal agencies under confidential contract terms
– Do not currently track customer “benefit location” for services or intangibles

What You Should Do Next 

At Larson Gross, our goal is to help you anticipate, not react. Here’s how we can help you prepare:

1. Revenue Diagnostic – We’ll help you map your revenue streams to the new sourcing rules.
2. Customer Location Review – Assess what data you have—and what you need—to determine customer benefit location.
3. Nexus & Filing Exposure Check – Evaluate whether these changes increase your risk of California filing obligations.
4. Methodology Memo Support – We’ll assist in documenting your reasonable approximation methods to stand up to audit scrutiny.
5. Tax Year 2026 Planning – We’ll help you plan proactively for the first tax year this rule takes effect.

Final Thoughts

California’s updated sourcing rules are complex—but they also bring clarity and opportunities for businesses who prepare in advance. For some, the changes may reduce California exposure. For others, they may create new filing obligations.

Either way, understanding how these rules apply to your business is the first step. We’re here to help you do exactly that.

Have questions? Let’s talk before year-end.

Larson Gross is here to walk you through these changes and help you make the most of them for your operation. Please contact us to learn more at 800-447-0177.