Zip Codes Mean “Zip” for Sales Tax Purposes

I just had to add a little background and history to yesterday’s post about zip code/sales tax issues:

Errors are not tolerated lightly when we dwell in the realm of taxes. Incorrectly charging sales tax can result in fines, audit penalties, or even class-action lawsuits. The only way to accurately apply a correct tax rate is by knowing the real geographic location, as well as the corresponding tax jurisdictions — from state all the way down to multiple special taxing jurisdictional levels.

Now for the mini history lesson. A cartoon character named Mr. ZIP in the 1960s began introducing the American public to a novel idea: the Zone Improvement Plan code, also referred to as the ZIP code.

This numeric system for categorizing geographic regions expanded on an older system of postal zones that included all of the United States, rather than only its larger cities. The system has become so well-known since then that the numbers have become almost synonymous for the areas they represent. For example, the series of numbers “90210” is rooted in the American psyche as Beverly Hills, California.

ZIP codes are such an integral part of our national lexicon that their use has crept into a wide variety of applications. They can tell a hungry resident whether their favorite pizzeria will deliver. Web surfers use them to locate the brick-and-mortar location of an online retailer. With them, businesses can track customers’ purchasing patterns. Insurance adjusters assign rates by them. Real estate agents use them to help value houses. These are all valid applications of ZIP codes!

But some people even use ZIP codes to determine tax rates. This practice is unreliable, at best, and can seriously risk audit, at worst.

ZIP codes were developed by the US Postal Service for the sole purpose of accurately and efficiently delivering the mail. They can overlap, be a subset of other ZIP codes, or represent no geographic region at all (for example, Smokey the Bear has his own: 20252).

A common misunderstanding is that the Post Office designated ZIP codes to designated a specific city. But let’s look a bit closer: 85254 is assigned by the Post Office to the place named Scottsdale, AZ. In actuality, the 85% of this postal region lies within neighboring Phoenix.

Some cities do not even have their own postal code: Centennial, Colorado is split among the 7 codes of the surrounding cities. And look to yesterday’s post for more on this issue.

ZIP codes are not static, either. They are divided and changed as areas become more densely populated. The boundaries can, and often are, redefined. The USPS reports that a staggering 1 of every 4 ZIP codes changes each year! When I lived in 10021 and it was slated to become 10075 — merely indicative of a section of New York’s Upper East Side that became (surprise, surprise) too overly populated, several 100’s, if not 1000’s, of my neighbors nearly had heart attacks from the anxiety of losing their geographical identity in a City that defines itself on a neighborhood level.

And whereas ZIP codes are created by the USPS, sales tax rate boundaries are set at state, county, and municipal levels. They do not have anything in common: In the state of Washington alone, the Department of Revenue reports that 40% of ZIP codes cross up to 5 different jurisdictional boundaries. The California Board of Equalization warns, “It is not always possible to determine the correct rate based solely on a mailing address . . . as a result, you may apply an incorrect tax rate.”

Use of ZIP codes to determine a sales tax rate can result in a potential error rate of 10%. And while the use of ZIP+4 can result in greater accuracy, it is still not by any means a foolproof method. Visit the Streamlined Sales Tax Governing Board’s Rates and Boundary Database Instructional Paper for more to think about in terms of 5- and 9-digit postal codes.SalesTaxBuzz

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4 Responses

  1. An interesting article from Bob Meador about accuracy in using ZIP codes for tax jurisdiction assignment: http://www.directionsmag.com/article.php?article_id=652&trv=1.

    He states that using a ZIP code to identify a tax jurisdiction results in a 10% error. Charging an incorrect rate 1 in 10 times seems huge, and likely withing range of interest during an audit. Additionally, 5% of ZIP codes change every year… so just because it is right today doesn’t mean it will be right tomorrow.

  2. […] Your choice may have an impact on the imposition of alternative minimum tax (AMT). This issue, as well as others, become only further complicated by whether you are a part-time resident or change residence during the tax year . . . it’s easy to understand how a seemingly simple decision is far from simple, after all. For example, even a local move, say within the same neighborhood, could mean you changed local taxing jurisdictions, even if you stayed within the same ZIP code. […]

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