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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.

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.

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.

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.
• 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:

1. Check out California sourcing requirements prior to taking on big out-of-state engagements.
2. Use a documented and reasonable method to separate revenue from California from other revenue.
3. Determine if there is any double taxation exposure in all applicable states.
4. When a contract includes multiple customer locations or complex services, seek advice from a multistate tax professional.
5. Keep Your Business Safe by Making Proactive Tax Plans

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.

There is no successor liability, same as responsible person liability. A buyer can be held liable without being involved in the seller’s previous tax planning.

The level and extent of liability will be determined by the relevant statutory provisions and circumstances. In general, the amount of exposure the purchaser has to the proceeds of a sale can be constrained by the purchase price and the amount of withholding proper, under the rules.

The CDTFA does not waive its right to sue a buyer in light of an indemnification clause in the purchase agreement. A contractual protection may give rise to a claim against the seller, but it will not necessarily preclude a tax assessment.

The performing of the due diligence should start when the final purchase documents are not yet signed, but before the closing.

1. Submit a request for CDTFA Tax Clearance

Have the seller obtain the necessary tax clearance/certificate from the CDTFA. Examine and identify if the document addresses the appropriate business, tax accounts, and liabilities.

2. Deny the Purchase Funds Needed

California law in general provides that a buyer must retain a specific portion of the purchase price from the sale of property until the applicable clearance or other statutory requirements have been satisfied, and the qualifying unpaid tax liabilities have been met.

If the seller says he/she will pay later, don’t release the withheld dollars. Follow the directions of the CDTFA and do not create your own.

3. Check Seller’s Tax History

Review sales and use tax returns, payment confirmations, notices, and account records. Search for unexplained balances, missing files, collection efforts, or large outstanding amounts.

4. Add Sundry Contractual Protections

Coordinate with an attorney for representation, warranty, and indemnification, and escrow agreements covering unpaid taxes. The provisions may be useful to distribute financial risk between buyer and seller.

5. Communicate with Escrow and Tax Attorneys

Provide a proper closing with the necessary withholdings, notifications, and clearances. A well-designed transaction can minimize the potential for an unexpected tax issue in the passing.

Don’t blindly accept an assessment because of a notice stating that you are personally responsible or you are a successor. But failing to reply to the notice could ultimately make it harder to contest it.

First, determine the basis for the assessment, the tax periods involved, the amount of income tax claimed, and the time limit for responding.

Then compile documents that outline the facts such as:

• Records of sales and use taxes.
• Payment approvals and bank statements.
• Bylaws for the corporation, LLC operating agreement, and job description.
• Emails and internal communications related to tax compliance.
• Business closing papers or acquisition and escrow papers.
• Documentary records of ownership of business money in the official records.

Where the assessment is based on the liability of the responsible person, evidence that you lacked the necessary authority, or that you were not responsible within the period of the assessment, or that you did not knowingly fail to pay, may be relevant.

Where there is a successor liability, review the purchase agreement, the amount withheld, clearance procedure, and whether the CDTFA properly applied the applicable statutory provisions.

Be mindful of deadlines. The review and/or appeal process available will vary based on the type of notice and assessment. Not all CDTFA notices have the same timeframe or procedure. Seek immediate advice from a California tax attorney.

There are several things that business owners can do so as to minimize the risk of unpaid sales tax being a personal financial issue.

• Separate out sales tax: Keep good accounting records and do not consider the cash received for the sales tax an unrestricted operating cash flow.
• Keep track of tax filing deadlines: Reconcile taxable sales, exemptions, tax returns, and tax payments regularly.
• Document financial decisions: Keep financial records that include information about who made financial decisions and how tax compliance decisions were made.
• Don’t delay in talking about challenges due to finances: If the business is facing financial difficulties, reach out to the CDTFA and discuss options for payment or other resolution prior to closure of the business.
• Document changes of roles in responsibility review: Document changes in management, financial authority, and tax compliance responsibilities.
• Don’t shut up without professional counsel: When your business shuts its doors, it doesn’t mean that all your tax liabilities go away or that your personal exposure to liability is wiped away.
• Perform tax due diligence prior to acquisitions: Tax clearance should be on the closing checklist, along with proper withholding.

Even if a business’s business owner transfers ownership, resigns as an officer, or dissolves an LLC or closes a storefront, the business owner should not presume that the tax requirements are automatically satisfied. The legal implications will depend upon the facts and the relevant laws.

In some cases, a taxpayer has the option to appeal the assessment, request a hearing with the CDTFA for administrative review, or discuss payment options with the CDTFA.

A responsible person assessment can be challenged if the agency has erred in identifying the person, determining the liability, or determining the applicable legal requirements. If the transaction, withholding, clearance, and/or calculation were done incorrectly, a successor liability assessment may need to be reviewed.

Financial hardship taxpayers also should consult a qualified professional about payment arrangements or other collection options. These don’t automatically cancel the debt and are not available in all situations.

Retain all submissions and agency communication. Failure to disagree with a determination doesn’t mean failure to file a protest or appeal, if necessary.

California’s successor and responsible person tax laws can leave buyers of businesses and individuals with significantly more obligations than they anticipated. Responsible person liability is concerned with the qualifications and actions of responsible persons, and successor liability can impact those buying a business with outstanding tax liabilities.

The best defense is to be proactive with compliance, document everything, and receive professional advice prior to a business closing or sale.

When a CDTFA notice is sent, review it, keep relevant records, and respond in a timely manner. Knowing what you’re required to do before a tax issue becomes an issue can mean better business results and a better financial life for you.

1. Can CDTFA hold a business responsible for unpaid sales tax?

Yes. As per California Revenue and Taxation Code section 6829, individuals can be held personally liable when certain criteria are met. This includes: Tax Compliance, Willful Non-Payment, and Closure of the Business.

2. What is successor liability under California sales tax law?

If you are purchasing a business, successor liability means you may be responsible for certain sales and use taxes due but not paid by the previous owner. Before completing a purchase, ask the seller for a tax clearance from the CDTFA. Make sure to meet any tax withholding requirements.

3. How to challenge a CDTFA personal liability assessment?

Make sure you understand the notice, check that the tax periods and amounts are correct, and collect any tax, financial, and documentation relating to your liabilities. Contact a qualified California tax lawyer as soon as possible to understand what options you have to appeal and any time limits.