Sales Tax 101 Sales Tax Rates

Why 5-Digit Zip Codes Don’t Always Return Correct Sales Tax Rates (And That’s OK)

by Graham Martin

Zip codes sales tax

This post will explain why, due to your customer’s zip code information provided, your eCommerce platform or sales tax software will sometimes charge your customers a slightly lower rate than you expect, and why you shouldn’t panic. It will all be okay!

Why 5-Digit Zip Codes Sometimes Create Sales Tax Confusion

When making an online sale, you, the seller, uses the ship-to address provided by your customer to calculate the sales tax you should charge. (To be fair, it’s probably not you literally doing the calculation. You’re probably using some kind of online sales platform or sales tax calculation software! Your online sales platform or software, in turn, is usually using information published by the individual states.)

Using that information, you determine which state, county, city and other special taxing jurisdiction your customer lives in. This helps you determine exactly how much combined sales tax you should charge that customer.

Example:

You make a sale to someone in with an address in Stillwell, Oklahoma. The Stillwell sales tax rate is a combined 4.5% Oklahoma sales tax rate + the 1.75% Adair County rate + 3.5% Stillwell city rate for a total of 9.75%. But if your customer has a Stillwell address but technically lives outside the Stillwell city limits, she may really only be on the hook to pay the combined 4.5% Oklahoma sales tax rate + the 1.75% Adair County sales tax rate for a total of 6.25%. Knowing whether or not your customer lives within or outside city limits can definitely make a difference in how much sales tax you charge her!

From this example – a customer with a Stillwell, OK address who does not actually live within Stillwell city limits – you can see that it’s not always easy for you or for sales tax software to determine each taxing jurisdiction your customer’s address falls into with just the information they provide.

Why is this? In many cases, customers only provide you with a 5-digit zip code to help you determine the sales tax rate you should charge them. Five-digit zip codes often cover a wide range of areas, including two, three or even more taxing jurisdictions. So with just a 5-digit zip code to go on, it can be difficult to determine if you’re charging the right sales tax rate.

If you’re reading this and suddenly worrying that you’ve been charging customers the wrong sales tax rate, fear not. Just keep reading!

Pro Tip: In order to ensure taxes assigned to local jurisdictions in SST states with the highest degree of accuracy, be sure to collect full street addresses, complete with a 9-digit Zip Code, from your customers or utilize an address validation tool like Smarty Streets to correct addresses and attach the +4 Zip Code extension.

How SST States Take Sellers Off the Hook for Zip Code Errors

States that are part of the Streamlined Sales Tax (SST) agreement are required to publish rate and boundary files for sellers (and online eCommerce platforms, and sales tax software) to use to determine how much sales tax to charge each customer. These files assign taxing jurisdictions to every area within the state based on the 9-digit or 5-digit zip code, or – in some cases – the complete street address.

As an online seller, here’s what you need to know about using this info to collect the right sales tax rate:

When using these state-provided files to assign taxing jurisdictions and tax rates, the most complete address record available is used. If no match is found for a street address or if the street address is not available, the 9-digit zip code is used to determine the jurisdiction and rate. If the 9-digit zip code is not available, the 5-digit zip code is used.

To promote accuracy in collecting sales tax, sellers are tasked with doing their due diligence and using the most complete street address available to them. (Source: Section 305.F)

But if your customer only provides you with a 5-digit zip code, then the SST agreement requires that you charge the customer the lowest zip code in the area covered by that zip code.

And here’s the best news:  if the 5-digit zip code is all the customer gives you to work with, the SST also says that the state has to “hold you harmless” of any errors (such as collected a too-low sales tax rate) made when using the state provided databases. In other words, if you used a software or online seller platform that returned a low sales tax rate based on sales tax info published by your state, you are not on the hook to pay the difference out of pocket.

Whew! Let’s look at another example:

Example:

Let’s say your customer lives at 312 Hurricane Lane, Willliston, VT 05495-2086. The address is indicated by the red star in both of these pictures:

Streamlined Sales Tax Address Lookup

You’ll notice that the boundaries of the zip code 05495 and the boundaries of the city of Williston are slightly different

When your buyer’s full address is used, the sales tax rate returned when looking this address up with the state is 7%. This includes the 6% Vermont state sales tax and the 1% local Williston sales tax.

When only the 9-digit zip code is used, the rate returned is 7%. This includes the 6% VT state sales tax and the 1% local Williston sales tax. The entire Zip Code area of 05495-2086 lies within the Williston city limits.

However, when only the 5-digit zip code is used, the rate returned is 6%. This includes the 6% VT state sales tax and excludes the 1% local Williston sales tax, because a portion of the 05495 zip code area does not lie within the Williston city limits. You can see that here:

05495 Zip Code Area

The SST agreement requires that the rate default to the lowest rate found within the zip code area, so the local tax is discarded. Even though this is technically not the correct rate for this address, it is deemed correct by default if no additional address info is available or if the address contains errors which would prevent it from finding a match in the database.

Whew! I’ll say it again because it’s important to hear: if you used a software or online seller platform that returned a low sales tax rate based on sales tax info published by a state that is part of the Streamlined Sales Tax Agreement (SST), you are not on the hook to pay the difference out of pocket.

Do you have questions or something to say about zip codes and sales tax? Start the conversation in the comments!

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