Since people know where they live, addresses are discrete and the U.S. Postal Service knows where to deliver mail via addresses, one would expect that assigning tax jurisdictions would be a simple task. Unfortunately, it’s anything but simple, owing to 54 states and territories, 7,600 local jurisdictions and more than 800 special tax districts (SpTDs) such as police jurisdictions covering more than 3,800 cities and/or counties that collect sales and use tax.
Special tax districts can be problematic because they add another layer of taxes, fees and assessments that must be paid. A number of them do not correspond to a defined county or city boundary, and the definition of such districts can be extremely complicated. They involve not only a general description of its location—including what ZIP codes it includes and whether it is inside or outside of a given city—but also a formal legal definition, which can be quite lengthy, describing the precise geographic boundaries starting with a "point of beginning" to a known major geographic position, such as a street centerline or a highway right-of-way.
The Roots of Tax Errors
Errors in assigning tax jurisdictions usually occur because a customer or service address is located incorrectly. Assigning a customer to municipal and county jurisdictions based on ZIP and ZIP+4 tables can generate errors rates of 5 percent to 30 percent. Billing departments need to be aware that these solutions have associated problems:
- Municipal boundaries constantly change.
- A postal city is not the same as a taxing city.
- Not all addresses have a ZIP or ZIP+4 code.
- 3,576 ZIP codes and 15,070 ZIP+4s cross municipal boundaries.
- 16,717 ZIP codes and 301,756 ZIP+4s cross county boundaries.
- Approximately 50,000 ZIP codes change quarterly or annually.
Simply put, ZIP codes and postal data were developed for delivering mail and are not accurate for establishing a customer’s tax "situs," or taxable location. As an example, ZIP code 80123 crosses multiple county and municipal boundaries in Colorado (see Figure 1).
Location Is Necessary to Determine Tax Jurisdictions Because tax jurisdictions constantly change and new SpTDs are created, location is vital to determining jurisdictions accurately. Location-based technology allows businesses to locate customer or service addresses precisely and compare spatially the location of the physical address to a tax database, such as Proxix’s National Municipal Boundary Database. A solution using precise geocoding, spatial analysis and updated tax databases delivers the highest level of accuracy for tax jurisdiction assignment.
The errors that can occur without accurate situsing have specific ramifications such as penalties, fines and other costs including legal fees and mandated refunds. Since it is difficult for providers to comply with all tax laws, they often expose themselves to either over-collecting tax from customers or collecting too little for state and local tax liabilities.
Of the two, over-collection is more common. These errors are usually detected first by customers who file complaints that they have been over-taxed. If a significant population of the customer base has been affected, the error could reach the media, triggering negative corporate publicity and a possible loss in revenue.
The class action suit Allen v. AT&T illustrates the scenario a company could face if it over-collects taxes. The plaintiffs alleged that AT&T had improperly charged customers who resided on the borders of municipal taxing jurisdictions in 28 states the wrong sales tax. The Oklahoma Court of Appeals upheld a lower court’s verdict that AT&T was responsible for refunding the over-collected taxes. Though this class action suit is an uncommon example, there is no question that service providers are held accountable when they over-tax in error.
Customers seldom complain about being under-taxed, so it is generally the auditor from a jurisdiction that finds the errors. Although under-collecting rarely gets media attention or prompts a class action, providers can incur significant costs. Beyond the penalties or fines, a provider in either situation will sustain external and internal expenses. External expenses are outside legal or consulting fees, as well as public relations or marketing fees for counteracting negative publicity.
Internal or overhead expenses can equate rapidly. Since a provider is responsible for rectifying errors, it first has to determine the affected customer base and establish the refundable monies, whether it is to customers or jurisdictions. These tasks are laborious and usually involve both the tax and IT departments. Additionally, a provider has to purchase other software that integrates into the billing system to correct the problems, because if a situsing problem occurs a provider can assume there are other jurisdictional errors.
However, acquiring additional software isn’t always a problem solver. Most tax software applications determine situs by city, state and ZIP or ZIP+4 code. The problem is that many legacy billing applications cannot handle the extra four digits of the ZIP+4. Even using ZIP or ZIP+4 codes, though, the software still cannot be definite in placing all addresses, so most undetermined service addresses usually default to a ZIP code’s major city or area.
Geocoding Technology
Although geocoding is rarely the end result for any application, it is the basis for understanding key geographic relationships necessary for decision management. Geocoding turns address data into spatial or geographic data by appending a latitude and longitude, which is a static geographic location of an address and never changes. Using the length of a street segment and address range assigned to the segment, geocoding approximates the location of an address. For increased positional accuracy, geocoding to the parcel boundary eliminates any ambiguity as to where an address is located. Overlaying the parcel boundaries on satellite imagery allows the users the capability of viewing the boundary lines and anything associated within, on or near the parcel. Parcel boundary geocoding is especially useful in rural areas, as the street length could be a half-mile or longer, and the placement of a geocoded point based upon an address could be 1,000 feet or more away from the actual location. This could potentially place the address in the wrong tax jurisdiction.
Using the latitude and longitude of the address, other geographic queries can be processed. The geospatial "point-in-polygon" computational process analyzes the spatial relationship of the latitude and longitude of a point (a customer address) to a designated polygon defining the shape of a jurisdictional area, such as a county, municipality or special tax district. Spatial analysis discovers which type of area the address is in or near and provides the greatest level of precision. Besides identifying proper tax jurisdiction, a location intelligence tax solution will calculate the distance between an address and the edge of the jurisdiction. This process filters border conditions and identifies potentially problematic cross-border assignments, such as those shown in Figure 1. Adding this intelligence to the assignment process provides a way to use business rules to generate a much lower percentage of errors.
Gathering the Data
The spatial data for determining tax jurisdictions must be collected from various sources. First, jurisdiction data must be obtained, including address lists from jurisdictions, county and municipal boundaries, SpTDs and street data. A county and municipal boundary database should include boundaries for cities, towns, villages, boroughs and selected census designated places (CDPs). It should also be based upon parcel data where it is available. This information should be monitored and updated regularly to reflect changes in annexation and de-annexation. Since SpTDs don’t always follow municipal boundaries and have their own geographic extents, this information helps to decipher whether an address is located within a special tax district, reducing guesswork by the provider. Industry-specific tax databases for the cable, telecommunications and utility industries also are an option and generally can determine whether a service provider is liable for collecting and remitting industry-specific taxes.
The Software, Data and Tax Rate Relationship
A provider has options regarding the technology it needs for accurate tax situsing. If a provider has a premium geocoder and spatial engine, then licensing the data is all that is needed. Researching different vendors is important, because not all vendors own and maintain their data. This is of importance because data is not static; it is constantly changing and therefore needs to be updated regularly. A vendor that owns its database can easily and regularly track and incorporate the changes. Third-party vendors often remain at the mercy of their OEMs before they can integrate changes and update their customers.
Solutions are also available for providers without a geocoder and spatial engine. It is preferable to choose a firm offering an integrated solution that includes geocoding, spatial analysis and data sources. A provider should also consider the ease of implementing the tax jurisdiction solution into its current systems. Today, Web services are becoming more widely available for companies that lack IT resources. Leveraging the Internet, providers can access the location technology and information they need, much like using MapQuest for driving directions. Most vendors have licensing options for those wanting in-house installation, but a provider should ask about renewal fees. At the end of a license term, a provider can be very surprised by steep renewal costs.
As a result of court cases like Allen v. AT&T and the financial certification required by Sarbanes-Oxley (Section 404), corporations have a growing concern regarding the overall accuracy of the tax situsing in their enterprise systems. The key to combating the complexities of tax jurisdiction is location intelligence. Without location technology integrated into billing, fixed-asset and tax systems, providers put themselves at risk for costly penalties and fines, as well as class action lawsuits.
Dan Lawson is director of tax applications at Proxix Solutions, Inc. (www.proxix.com). He can be reached at dlawson@proxix.com or at 972-317-6188.
