Trend Update: Sales Sourcing Changes for Services

Trend Update: Sales Sourcing Changes for Services

June 30, 2022

Jeanna Schenk, CPA, MST

Firstly, how do sales apportionment sourcing rules work? A little background…

Sales apportionment sourcing rules are known to be complex and changing along with the business environment.

There are three methodologies for sourcing sales from services:

  1. Service performance – receipts from providing a service are sourced to the location where the service is performed.
  2. Cost of performance (COP) – receipts earned from the performance of services are apportioned to the state where the taxpayer incurs the costs of performing the services. This could be where the personnel are paid to perform the service (payroll) or where the equipment is physically located to perform the service (rent). Generally, COP is easier to apply because a company can look to where their costs are being incurred.
  3. Market-based sourcing – determining where a taxpayer’s “market” or “benefit” is located can be a bit more difficult. The goal is to assign sales based on where the customer is receiving the benefit of the company’s services. This is generally where the customer is located.

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The goal of market-based sourcing is to more accurately reflect the customer base for the taxpayer’s services and look towards the “destination” of the service revenue. The rules vary by state, but generally each state looks at:

  1. where the benefit is received,
  2. where the service is received,
  3. where the service is delivered, and
  4. where the customer is located.

For example, California assigns service revenue based on where the benefit is received—in other words, the location of where the customer has directly or indirectly received value from that service.


To show how different state sourcing rules can have huge positive and negative impacts to taxpayers, consider a company domiciled in Oklahoma with a customer in Texas (creating nexus in both states) and that all the work is performed in Oklahoma. Nothing would be sourced to Texas because none of the services are performed in Texas, and Texas is a service performance state.

Nothing would be sourced to Oklahoma either because Oklahoma is a market-based state and the market in this case is Texas. This is an example of nowhere sales, where the sales are not sourced to any state.

Alternatively, if the company is domiciled in Texas with a customer in Oklahoma and all the work is done in Texas, the sales would be sourced to BOTH states because all the work is done in Texas, but the market is in Oklahoma. This is a negative example where the company gets whipsawed by both states, showing the impact and importance of different states’ sourcing rules and the impact they can have on taxpayers.

An update on current sales sourcing methodology trends…

There are now only a few states that follow a COP methodology, including Alaska, Florida, Kansas, and North Dakota. Only a few follow the service performance methodology as well, including Delaware, Mississippi, and Texas.

In the last several years, the trend has been of most states moving to market-based sourcing methodology and single sales factor apportionment. This has the effect of increasing the tax burden of out-of-state service providers.

The use of market-based sourcing minimizes the importance of where costs are incurred. The reasoning behind the movement to single sales factor apportionment is that, in general, three-factor apportionment disincentivizes companies to locate their property and employees in a state. In a three-factor apportionment state, the apportionment percent will be impacted by the property and payroll being located in the state. In a single sales factor state, the property and payroll locations are not a factor and sourcing is solely based on the markets for sales.

How are some state trending?


On March 25, 2022, the California Franchise Tax Board (FTB) put forth a new analysis needed to assign service receipts to businesses under market-based sourcing rules. California is essentially further detailing how to approach market-based sourcing for California purposes. The FTB wants the service receipts sourced to the location where the direct benefit of the service is received by the end customer, not just the taxpayer’s customer.

Learn more: California FTB Provides Guidance on Sourcing Service Revenues with Legal Ruling 2022-01»


Market-based sourcing was enacted by HB 1185 on June 4, 2018. It is effective for tax years beginning on or after January 1, 2019. They define receipts sourced to Colorado “to the extent the service is delivered to a location” within Colorado.


On March 16, 2022, Idaho enacted single sales factor apportionment and made the change to market-based sourcing for service receipts.


Market-based sourcing was enacted for New Hampshire for taxable years ending on or after December 31, 2021. The state defines that receipts are sourced to New Hampshire when “sales of services are delivered to a location within the state.”


Market-based sourcing was enacted on September 8, 2020, effective for tax years beginning on or after July 21, 2019. They define that receipts are sourced to New Jersey if “the benefit of the service is received in New Jersey.” If that location cannot be determined, then the company should source to the location where the services were ordered.


Market-based sourcing was enacted by Senate Bill 557, effective for taxable years beginning on or after January 1, 2020.


In Texas, gross receipts from a service are, generally, sourced to the location where the service is performed. This is usually the location of the receipts-producing, end-product act. If services are performed inside and outside Texas, then receipts are attributed to Texas in proportion to the fair value of the services that are rendered in Texas.

For example, Texas also has separate rules for certain other activities like advertising and internet hosting. Advertising receipts are sourced based on the location of the audience. Internet hosting receipts are sourced to the location of the customer.

On March 25, 2022, the Texas Supreme court ruled in the case of Sirius XM Radio Inc. v Hegar, which is a Texas franchise tax case regarding apportionment of service receipts. In this case, Sirius XM sourced its subscription receipts based on the locations from which it produced programming. The Comptroller contended that the taxpayer must look to its receipt-producing, end-product act to determine whether the services were performed in the state.

The Texas Supreme Court ruled that service revenue should be sourced to the state where the service is performed, not the receipt-producing, end-product act argued by the Comptroller. The court agreed that the use of the receipt-producing, end-product act is applicable to determine “what” qualifies as the service performed but is inconsistent with Texas law when used to determine “where” a service is performed. This test can still be used to determine what the service performed is, but further analysis may be required to determine the location of the services performed.

It is of the utmost importance to keep up with different state laws and how they apply to you.

The changing sourcing rules can be complicated and vary by state—especially with the changes to market-based sourcing. And within market-based sourcing states, it’s essential to consider different rules for services as those rules may differ between states as well. Reach out to REDW’s trusted state and local tax advisors to discuss how your source income can have a large impact on your state income tax footprint. We welcome your questions.

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