Market-based sourcing attributes sales of services to where the benefit is received, often requiring a “look-through” rule to identify the ultimate recipient. As in the Humana case, sourcing tax revenue across states when a look-through rules applies is anything but straightforward.
By Judy Vorndran and Stacey Roberts
Sourcing of transactions for tax purposes affects both sales tax and income tax. Many states have transitioned from cost of performance-based sourcing to market-based sourcing for sales of services for apportionment purposes. This shift is not entirely new, but it raises the question: what does market-based sourcing mean? Each state has its own definition, adding to the complexity.
Recently, a case in Minnesota highlighted just how complex sourcing has become, particularly in how services are provided and should be sourced for income tax purposes.
The Minnesota Case: Humana
The Humana case, decided in November 2024, is a prime example. Minnesota’s rule for market-based sourcing states that sales of services are sourced to Minnesota if the benefit of the services is received in Minnesota. While the statute is straightforward, applying it can lead to different tax outcomes when considering the “look-through” rule.
The look-through rule involves looking beyond the immediate customer to the customer’s customer. For instance, an insurance company might be billed in Connecticut, but the insured individuals or businesses across the country receive the benefit of the services. The Humana case applied this rule, even though it wasn’t explicitly stated in Minnesota’s statutes. The courts decided that the plan members received the benefit of the services, invoking the look-through rule.
Broadly Applied Principle
This look-through rule isn’t limited to insurance companies. It can apply in various situations, making it essential for taxpayers to understand how their services should be sourced. For example, a client selling online coupons for manufacturer discounts found that revenue sourcing depended on where the coupon was redeemed, not where it was paid from. This can lead to conflicts between states, each wanting to claim the revenue.
Taxpayers must carefully analyze how they make their money, where it’s billed, and where it’s served or serviced. Multiple transactions in the flow of commerce can complicate sourcing revenue for income and sales tax purposes. Insurance is a clearer example, but the principle applies broadly. Tax preparers must look beyond the bill to address to understand how sales revenues are earned and paid.
Taxpayers cannot readily decide sourcing in state and local tax without a thorough understanding of market-based sourcing and this look-through rule. TaxOps can help taxpayers develop a comprehensive plan to attribute revenue accurately across states, ensuring compliance, minimizing conflicts, and reducing the risk of overpayments. Reach out to one of our business tax advocates today.
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