Tax Jurisdictions Challenge Billiers

One of the least understood and most often neglected issues in billing and taxation is the assignment of accurate tax jurisdictions. For many businesses dealing with large geographic areas and multiple jurisdictions, assigning the correct tax jurisdiction is crucial to determining the right rates, and correctly reporting and disbursing tax revenues.

In more than a third of the states, various taxes are levied on products and services down to the local municipality level. So, accurate jurisdiction assignment in many instances is more than just knowing the right state and the right county. Certain special tax districts have the authority to levy taxes, as well; public safety areas, mass transit authorities and school districts are the most notable examples.

Tracking local jurisdictions is tricky

In almost all instances, companies can identify the correct state and county. Because states and counties have highly stable geographic boundaries—no states and only six counties have changed boundaries over the last decade—tax errors at this level are usually caused by inaccurate data processing, not by boundary changes.

But it’s a different story when assigning an address to the right city or town. More than 3,000 municipal place boundaries changed in 1998 alone. That’s nearly one out of every six of the approximately 19,000 incorporated places in the United States. Those are very significant changes.

The Concept of ‘Place’

Incorporated municipalities, those with the potential to charge taxes, must be identified as “places” by the U.S. Census Bureau. States also designate unincorporated areas with significant population density as places. This leaves large areas of the country, particularly rural areas, not specifically identified as places. According to this approach, then, any area in the United States can be designated as an incorporated place, an unincorporated place, or outside a place.

In some areas, there are few or no boundary changes. But in areas of rapid population growth, municipal boundaries change rapidly. For example, of the 400 municipalities in Florida, 100 changed their boundaries in 1998. Of these same 400 municipalities, 300 charge public service taxes on telecommunications.

Take the example of BellSouth in Florida. An addressing malfunction in BellSouth Mobility’s proprietary system in 1999 created improper local tax surcharges on subscribers’ bills. Wireless customers in Monroe County for months had been charged a 7 percent tax that should have been charged to Dade County customers. BellSouth’s billing department had to manually review thousands of bills to pinpoint problem accounts and calculate refunds.

Tracking boundary changes is just one part of the challenge; assigning the right tax jurisdictions to a specific address is equally difficult. Historically firms have relied either on homegrown systems that are manually derived and often difficult to maintain, or have purchased systems typically based on five-digit ZIP codes. The latter approach takes the street address, city name, state and five-digit ZIP code, assigns a geographical code to the record, and cross-references that geocode to the tax rate table. Tax table companies use either the FIPS (Federal Information Processing Standard) geocodes published by the Census Bureau, or a proprietary format.

Address-to-geocode technique

The main data association in the address-to-geocode technique is based on the 5-digit ZIP code. A major complication with this approach is that 5-digit ZIP code areas can be large enough that they encompass multiple places or areas outside of places. One carrier recently stated that in one major metropolitan area it found roughly 90 percent of 5-digit ZIP codes lay in multiple tax places. Its current system couldn’t automatically identify which tax jurisdiction and rate were correct for each customer address. Consequently it was forced to use other sources, such as querying the customer or local government officials. The administrative costs for this kind of manual tax compliance are high, as is the risk of incorrect taxing.

Benchmark showed 5-digit inaccuracy

Group 1 recently conducted a benchmark of 26 major metropolitan areas to assess the accuracy of using 5-digit ZIP codes. The point of this exercise was to determine the likelihood that a valid city address was actually legally in the same place. In other words, if a customer had a Seattle postal address, what were the odds that the customer was in the municipal place called “Seattle”? The study revealed a roughly 1-in-3 chance that, even with a valid city postal address, the actual location was outside the city’s legal boundary. In those instances, the actual location could be in another incorporated place, an unincorporated place, or an area outside of a place.

The results were derived by identifying all valid 5-digit ZIP codes for each city, and then all valid 9-digit ZIP codes for each valid 5-digit code. Next, Group 1 cross-referenced the 9-digit ZIPs to determine accurate place information. By using the 9-digit ZIP codes associated with each ZIP, much smaller, finite areas could be identified than by the 5-digit code alone. A 9-digit ZIP code corresponds to a street segment or city block, and typically only one side of a street. A highly accurate system that cross-references 9-digit ZIPs to places can determine in which places and non-places the addresses actually reside.

Boundary issues largely ignored

Few carriers appear to be aware of these boundary issues and the ever changing status of addresses. For smaller companies subject to less audit scrutiny, this uncertainty is probably not a major threat, at least for now. For larger carriers, however, the errors of traditional practices can result in financial exposure too steep to tolerate. The risks include potential back taxes and penalties, and possible class action suits from incorrect tax assignment—to say nothing of the potential loss of customer satisfaction and damage to public relations.

Martin Sohovich is director and GeoTAX product manager for Group 1 Software in Lanham, Md.