Accurate sales tax determination is historically predicated on the seller knowing the precise street address of their customer. Since sales tax jurisdictional boundaries do not necessarily correspond to governmental boundaries (e.g., state, county, city) and don’t tightly align with zip codes, the only way to apply correct local rates is by knowing the pinpoint location of the buyer. However, in today’s digital economy, unless a physical good is being shipped, digital sellers do not need to know the customer’s exact location and their customer may be hesitant to share that information.
The Member States of the Streamlined Sales Tax Governing Board, through recently adopted amendments to the Streamlined Agreement, have attempted to carve out a path to compliance for taxpayers coping with this business reality.
The business challenge for digital sellers
Many digital sellers have configured their billing systems to neither request nor require their customers to provide their street address. However, they often will collect five-digit zip code data. While zip codes are likewise not needed to deliver a digital product or service, having a customer zip code on file allows the seller to effectively confirm the authenticity of the buyer’s payment instrument.
However, in states with local sales tax, zip codes are not sufficient to accurately determine the correct local rate. The limitations and inaccuracies of applying sales tax based exclusively on the zip code of the buyer are chronicled in a Sovos White Paper, Taxing the Digital Economy: The Anachronism of Street Address, from 2023. In that paper, we also discuss the conundrum of cart abandonment and the challenge of data security as legitimate reasons why a seller may not wish to change their process to compel a buyer to provide their street address.
In short, sellers place a premium on frictionless commerce and any barrier that they place in front of completing the transaction could cost them sales. At the same time, companies want to do everything possible to stay out of the press and out of the legal system when it comes to the adverse consequences of data piracy and theft of personally identifiable customer information. Buyers themselves may have good reason for not wanting to share their street address, including a reasonable desire to minimize the information they share about themselves online.
Collecting just the buyer five-digit zip code seems to satisfy the requirements of both buyers and sellers.
The regulatory conundrum
This challenge was brought to the attention of the Streamlined Sales Tax Governing Board 3+ years ago by several of the Certified Service Providers (CSP’s). They explained that over the years, they had conversations with companies who would have liked to have come into compliance through the CSP program (which defrays the cost of compliance through direct state compensation of the CSP’s) but offering services to these companies was challenging because the SST Member states required street-address level data for all transactions as ultimately reflected in the required audit files. Likewise, the contract between the SST Governing Board and the CSP’s requires the CSP’s to collect street-level data.
By no means is this challenge limited to the CSP context. Many states hold to the proposition that sellers are legally bound to collect street address data from their customers as a matter of fundamental sales tax compliance. The states likely did not understand that steadfast adherence to this requirement precluded many digital sellers from voluntarily coming into compliance, including sellers from outside the United States that are unaccustomed to the need to account for local-level taxes.
A hard-fought compromise
Finding a reasonable middle ground was incredibly challenging, made even more difficult because the SST Member States must produce a “boundary file” that aligns five-digit zip codes, nine-digit zip codes, and street addresses (optionally) to local tax rates. Under the rules, states must align the five-digit zip code record with the lowest rate associated to any location within the zip code. Since many zip codes include areas that are outside city limits, the associated rate is often just the state rate. This means that if a seller uses only the five-digit zip to determine the proper tax rates, the answer the boundary files will often produce is the state rate only, leaving off any local tax. Conversely, the boundary file generally applies any applicable local tax when a buyer provides their +4 extension, but this is often rendered moot as most Americans don’t know their +4 and a +4 extension cannot be derived unless you already know the exact street address.
The initial position staked out by the business community was that states should accept sellers collecting only zip code data and the attendant tax result, noting that the benefit of bringing digital sellers into compliance exceeded the recognized minor loss in local tax revenue. The states, on the other hand suggested that sellers should simply be compelled to collect street address information from al their customer and failing that, at least the +4 extension.
With these positions in hand, the State and Local Advisory Council (SLAC) and the Business Advisory Council embarked on a multi-year negotiation, culminating in amendments to the Streamlined Agreement adopted on May 15, 2024. Fundamentally, the new requirements are as follows:
- States are allowed to change their boundary file such that the zip code records could apply the highest rate in the zip code area or a “blended” rate. Of course, nothing prevents states from continuing to apply the lowest rate as they do today.
- If the sale is of the type that does not require a street address (e.g., electronically supplied services or digital products) then a seller must ask the buyer for their street address and/or +4 extension even if in the end the buyer chooses not to provide it.
So long as the seller fulfills their legal obligation to ask, the seller or the CSP can use the boundary database to apply tax based on the zip code and the state is precluded from assessing any additional liability by suggesting the seller was non-compliant in not collecting tax at the rate for the customers actual street address.
Is it really a compromise?
A well-known axiom suggests that the best compromises leave neither side completely happy with the result, and it’s true that the business community is not fully satisfied. Specifically, they have legitimate concerns that giving the states an ability to apply the highest prevailing rate on the zip code record in the boundary file violates the Internet Tax Freedom Act, which prohibits states from imposing discriminatory taxes on electronic commerce. There is also concern that this approach runs afoul of the Supreme Court Holding in Associated Industries of MO v. Lohman, which holds that a Constitutional violation exists whenever a rule may require an out-of-state seller to pay tax at a higher rate than their in-state brethren. Business representatives strongly believed states could have ameliorated this worry by providing taxpayers with the right to request a refund of any overpaid tax, but a mandatory refund provision contained in earlier drafts was eliminated.
What’s next for digital sellers
Under the SST bylaws, any change to the Agreement requiring at least one sate to make a legislative change must be voted upon twice by the Governing Board before it takes full effect. Since both Vermont and Tennessee suggested a legislative change will be needed, these changes will be voted on again. This should happen no later than the next scheduled Governing Board meeting in early October, but its quite possible that the Board will convene a special session specifically to hold the second vote.
Still lots to unpack here. Now that the cards have been dealt, it’s time to see how the players execute their strategy. Will these changes be implemented on the ground and what can we expect from businesses? Will some states look to take advantage of the option of blended or higher rates? Will states need to effectuate any legislative changes, and if so, what will those changes look like and when will they become effective? The hope is that sellers avail themselves of this option to come into compliance, but as we all know, hope is not a plan.
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