As automation and AI become more integrated into sales tax systems, many businesses assume these tools can completely replace human input. While tax engines and AI models are powerful in managing and applying tax rules, they rely on the accuracy of its inputs, or tax mappings.
What Is Tax Mapping and Why It Matters
Tax mapping is the process of aligning a company’s SKUs to the tax codes associated with a tax engine. The tax engine understands the taxability associated with the specific tax code throughout the country including the applicable tax rate. Companies that provide tax engines generally have CPAs, tax experts, and attorneys on staff that continuously monitor tax statutes to ensure the logic and content within the tax engine is current. A tax engine is a great way to automate the determination and application of sales tax when invoicing customers or from within a shopping cart. AI can help facilitate the mapping process for a large number of products and even services. However, I’ve seen challenges with tax mapping, and the over-reliance on AI to deliver the proper mapping in the following scenarios:
What are you selling?
It’s not always clear what a company is selling. A company could claim to sell SaaS, but upon further discovery it’s possible the company is selling something other than SaaS. For example, it could be an information service or a data processing service. Simply reading the description of the product and aligning the description with a corresponding tax code could result in a significantly different, and incorrect outcome in terms of the application of the sales tax. I’ve seen this play out in many situations, and I’ve often stated that one of the most difficult aspects of mapping and/or providing a taxability analysis is understanding what is being sold. You need to understand:
- Who is the user?
- How do they interact with the product/service in question?
- What does the product/service deliver back to the user?
How is this information delivered back to the user?
- And more..
Each of these questions is critical to understand what is being sold and therefore what tax code it should be mapped to.
Are you selling a bundle?
Bundles are generally defined as the sale of two or more items together as a single item/solution for a single price. It’s common to see bundles that consist of taxable and non-taxable components. While each state looks at bundles a bit differently, generally if you bundle a taxable and non-taxable item together, the entire bundle is going to be taxable. Sometimes, you might have to assess the value of each individual component, and based on each state, you may need to determine whether the taxable component comprises a significant enough value of the total offering which would “taint” the entire bundle and cause it to be taxable. Furthermore, when looking at bundles in the telecommunications industry, each individual component of a bundle can be mapped to its respective tax code in the tax engine, applying a revenue allocation to each individual component, and a different determination to each component. This “unbundling” concept is a generally accepted practice when determining which components of the bundle are assessable for Universal Service Fund (USF) purposes. However, most states are less tolerant of the unbundling concept. As a result, the tax engine you work with should have the ability to manage these bundles on a case by case basis.
The Best Approach: Combine Automation With Expert Oversight
In short, while AI can assist in managing and automating tax mapping, it lacks the context and judgment that comes from human expertise in more complex situations. Mapping errors can lead to over-collection, under-collection, and unnecessary audit exposure. The best approach combines automation with experienced oversight, using technology for efficiency while relying on human understanding and experience to ensure every product, bundle, and code aligns with the correct tax treatment.
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