Key Takeaways:
- California removes customer-type distinctions and introduces sourcing presumptions based on the nature of services and property involved.
- As the taxpayer, your method will be upheld unless the FTB can show, by a preponderance of the evidence, that it isn’t reasonable.
- The “average value of interest” test and investor-based sourcing may increase California apportionment for out-of-state asset managers.
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Effective Tax Year Beginning January 1, 2026
After years of public hearings and multiple rounds of draft language, the California Franchise Tax Board (FTB) has finalized amendments to its market-based sourcing regulation under Cal. Code Regs. tit. 18, §25136-2. These updates reflect substantial shifts in how service and intangible income is sourced to California and will apply to tax years beginning on or after January 1, 2026.
For tax executives, CFOs, and compliance professionals, these changes bring both opportunities and challenges in managing California apportionment.
Key Updates
Highlights of the amended regulation include:
- Elimination of customer-type distinctions: The former rules that differentiated between business and individual customers have been removed.
- Sales of marketable securities: Updated guidance now applies to how these are sourced.
- Presumptions for service types: The regulation now includes sourcing presumptions based on whether services relate to real property, tangible or intangible property, or individuals located in the state.
- Use of available data: Taxpayers may rely on books, records, and other information to determine the location where a customer receives the benefit of a service—provided it’s reasonable.
- Government contracts: New rules guide sourcing when U.S. government contracts limit disclosure or data access.
- Asset management services: A new “average value of interest” test applies, using a look-through approach to investor domicile.
- Large-volume service providers: Taxpayers serving over 250 customers are subject to new sourcing guidance.
- Sales involving mixed property and service elements: Guidance is provided on transactions involving services and tangible or intangible property.
- Dividends and intangible sales: Clarifies how to apply the 50% asset test when complete data is unavailable.
What This Means for Mid-Market Taxpayers
These updates are not just clarifications—they represent a notable shift from the rules effective through December 31, 2025. One significant change is the rebuttable presumption in favor of the taxpayer’s reasonable approximation method, placing the burden on the FTB to demonstrate, with a preponderance of the evidence, that a method is unreasonable.
For asset managers, especially those operating across state lines, the new sourcing framework could be impactful. Firms located outside California may now see a larger share of income sourced to the state if they serve California-based investors. Conversely, in-state firms may benefit when servicing out-of-state investors.
Planning Ahead
Although these changes won’t apply until the 2026 tax year, affected businesses—particularly in the asset management, professional services, and technology sectors—should begin reviewing sourcing methodologies now.
Considerations for CFOs and tax leads include:
- Reviewing current approximation methods and whether adjustments may be necessary;
- Submitting pre-approvals if method changes are planned;
- Evaluating the data infrastructure needed to comply with substantiation rules;
- Modeling potential apportionment impacts based on the new rules;
- Engaging with advisors to discuss implications and future strategy.
Bottom Line
California’s finalized regulation marks a significant evolution in market-based sourcing. Businesses with multi-state operations or complex service models should start evaluating potential apportionment impacts now to stay ahead of compliance requirements.
How MGO Can Help: Providing Strategic Guidance to Help You Adapt to California’s New Sourcing Landscape
Navigating California’s revised market-based sourcing rules requires more than simple awareness; it demands a clear strategy. MGO’s SALT team works closely with your tax leaders to assess your current sourcing methods, identify areas of your exposure, and develop compliant, data-driven approaches that align with the updated regulatory requirements. Whether your business is adjusting for the new asset management provisions or reassessing your service-based income streams, our professionals bring industry-focused insight to help you evaluate risk, streamline compliance, and ultimately…plan with confidence. Contact us to learn more.