Accurate Tax Jurisdiction Assignment - A Difficult and Complex Proposition

By Bob Meador

Meador Collecting and disbursing sales tax revenue is a major challenge for businesses working in states that have a variety of sales tax jurisdictions.Tax collection has become very complicated and sophisticated in the last decade as a result of tax rates being assigned by point of use as opposed to point of sale in many states.

As states have legislated new requirements to manage tax assignment by locality (driven by the telecommunications industry as mobile phones came into widespread use), the complexity has grown to where it is mandatory to have an automated system to manage the process.In Colorado, for example, sales taxes are based on where your new refrigerator is delivered to, not the location of the store you bought it from.In addition, many states have legislated Special Tax Districts.

Special Tax Districts require additional tax rates and don't necessarily match municipal boundaries or ZIP code boundaries.There are several important factors therefore, that need to be considered to be sure an organization is comfortable with the overall accuracy of the process used to make a tax jurisdiction determination.

Businesses in the telecommunications, insurance, electric and gas utility, and the services and retail industries are all impacted in various ways by the need for accurate sales and use tax assignments.Collecting too much tax is as much as a problem as under collection.Whether collecting taxes at the point of delivery or assessing/collecting taxes in monthly utility bills, accuracy in determining the correct tax jurisdiction is a key component.

Most companies today still use tax determination packages that rely on determinations at the ZIP Code level.Tax rates are assigned based on the ZIP Code attached to the address.As not all ZIP Codes fall fully within a tax district, this results in a potential error rate of about 10 percent.It is also important to be aware of the currency issue as some 5% of ZIP Codes change each year.Using a ZIP+4 Code further improves the accuracy, but still the tax rate is assigned based on the ZIP Code.This has been acceptable in the past as few companies faced the potential for serious fines or other significant consequences for the potential 10% error rate.In today's world however, inaccurate tax jurisdiction assignments can have serious implications resulting in class action suits, fines, bad public relations, and poor customer relations.

Further complicating the tax assignment accuracy problem is the fact that most company customer address listings contain significant errors.Research indicates that up to 40 percent of the name and address information gathered from customer touch points, including point-of-sale, Web sites and call centers, contain errors such as incomplete addresses, misspelled street names, and missing ZIP Codes.The most cost effective way to improve on these results is to introduce highly accurate geocoding technology coupled with data quality processes to "correct" the address errors.These addresses must then be used with the most current and complete boundary data available today.

Data Quality and Geocoding
As mentioned above, one of the primary functions of geo-coding software is to correct, clean and standardize addresses to conform to United States Postal Service (USPS) conventions.States and businesses need to be confident that addresses are complete according to official standards.The initial stage is address standardization.The standardization software can "clean" the addresses by comparing it to a reference data base and appending missing or incorrect information based on the most similar match.Once cleansed, the address is geocoded to the street level which determines the actual location (latitude/longitude) of the address based on the address range in the reference spatial street data base.Once an address has been "standardized," it should be retained in any associated files to reduce mailing costs and to speed up future processing.Data currency of the street network file is a prerequisite for good results.Some street network vendors make over a million changes a month to their nationwide databases so currency can have a significant impact on the geocoding results.

Cross-reference Boundary Files
Once an address is geocoded and assigned a street-level latitude/longitude, a number of data elements describing the various taxing authorities can be used for determining the correct tax jurisdiction assignment.The data files contain information in electronic form about such items as municipal boundaries and special tax districts, etc.Look up tables or point-in-polygon analysis then determines whether a geocoded address falls within a given polygon region such as a municipal boundary or special tax jurisdiction. Data currency is another key prerequisite for accurate results.Each year thousands of municipalities change boundaries due to annexations and de-annexations. States and businesses need the ability to monitor and respond automatically to boundary jurisdiction changes.

Integration With Third-Party Applications
The software will need to be used in combination with many third-party tax rate determination, tax compliance, billing, enterprise resource planning, and payroll systems. To facilitate the flow of information to these applications, the tax software vendor must provide the software tools, standardized data formats, and professional services support to ensure maximum effectiveness.

The risks of error are great in this world of constant change.Data cleansing tied to street level geocoding tied to very current reference data can significantly reduce the multitude of risks to a manageable level.

Published Saturday, September 18th, 2004

Written by Bob Meador

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