Motor fuel excise tax survival guide
The complexity of motor fuel taxation is staggering
As a tax manager in fuel supply, distribution, or retail business, you know that an excise tax audit may be given without notice by any of your jurisdictions, whether state, county, city, or federal. So have you ever wondered how you’d survive a surprise audit?
Your lead tax preparer may be trekking in the Yukon Territory, but he has left detailed records for every single gallon for which there is a tax liability, right? The exact gallons, exempt or non-exempt status and all required information is meticulously recorded on every transaction for a smooth audit, right? Or are you in a panic, thinking, “Wait, did we sell gasoline in Dade County, Florida on invoice number #8675309 or was that in St. Lucie County and what were the environmental rates for each last year? And is it listed as St. Lucie with a period, St Lucie, or Saint Lucie? Now the auditor needs to know what late loads we filed in California just after the rates changed for dyed diesel, 3 years ago. Was that split load to Texas on April 27, 2012 reported as under or over 8000 gallons? And no, I was not personally aware that antimony is considered a taxable fuel in New Jersey. Where do I find the latest information to avoid paying a penalty for incorrect reporting of fuel taxes?”
This scenario is all too real. Excise tax complexity makes it difficult for any company to track, calculate, and file taxes accurately. Compliance failure carries serious consequences such as significant penalties and interest, additional filing requirements, or even license suspension or revocation. For example, the Internal Revenue Service can impose a $10,000 penalty for each erroneous Terminal Operator Report or Carrier Summary Report filed for each terminal and storage location, plus applicable taxes and interest. Mistakenly reporting something as simple as a product code for an entire year could lead to a penalty of over $1 million.
In this paper, we will summarize the top seven challenges facing tax managers today, and how to deal with them.
Use this survival guide to help you address these challenges and successfully navigate the treacherous waters of motor fuel excise taxes.
Challenge #1 – Keeping up with rules, rates and forms
Survival Tactic – Actively monitor jurisdictions or subscribe to a tax update service
Fuel industry tax departments are challenged by the complexities unique to excise tax at the city, county, state and federal levels. While there may be some similarities, each jurisdiction has its own set of tax laws, tax rates and reporting requirements. Governments are searching for ways to compensate for the decrease in fuel tax revenues caused by greater vehicle fuel efficiency, inflation, and the increasing use of alternative fuels. Taxing authorities are increasing tax rates, collecting tax where they have not done so in the past, and increasing audits. In fact, in 2013 there were 483 fuel tax changes in the US, and increase of 216% in just the past two years. Furthermore, these tax regulations can change with as little as 30 days’ notice.
Monitoring these types of changes may be manageable if your company is only filing in one or two jurisdictions, but the required effort and risk of making mistakes increases considerably if filing in 10 or more jurisdictions. The stakes are high for companies that can’t stay on top of the changing tax code. For example, by using the incorrect tax rate and underpaying your tax liability, you are not only exposed to audit risk and the stakes are high for companies that can’t stay on top of the changing tax code. The difference to the taxing authority, with an additional penalty plus interest. For example, the state of Illinois charges 10% of the total tax due or $50, whichever is greater, for tax underpayments, and can charge an additional 20% if the act is deemed negligent. On the flip side, overpayment of tax liability lowers cash flow and reduces profits.
In order to keep up with constantly changing tax rules and mitigate the risk of non-compliance, tax departments must actively monitor their tax jurisdictions and implement new tax rate and rule changes on a timely basis. In some cases, these new rules may require IT code changes or significant changes to manual processes. Tax departments can review state websites and notifications, or they can subscribe to tax content services that will notify them automatically when there are rule, rate, or form changes for their jurisdictions. These services are sometimes bundled with software to automate excise tax identification, calculation, or filing.
Challenge #2 – Managing licenses and exemptions
Survival Tactic – Track licenses and exemptions in a database linked to transactions
Depending on the rules in each taxing jurisdiction, your business may have transactions that are exempt from fuel tax. It is the seller’s responsibility to collect, validate, and keep on file an exemption certificate for each exempt transaction. This requires your business to keep a copy of each exemption certificate and ensure that certificates are renewed when they expire. If a certificate expires or is invalid, this leaves your business liable for paying uncollected tax and reduces your profit.
Exemptions don’t always mean zero tax liability. Some jurisdictions allow a flat percentage exemption on the final tax liability. Others require a qualifying transaction to be reported on a separate schedule, or a different rate when billed within a specific time frame. These rates often only apply to certain products.
For easier accounting and audit support, a database or spreadsheet of exemption certificates should be easily accessible and a management process in place to ensure their proper collection, validation, and renewal. For larger companies, the best solution integrates directly with your invoicing system, making it possible to verify that exemption certificates are current, valid, and on file prior to the sale. This also makes it possible to link specific certificates to each transaction to support audits.
Challenge #3 – Error-prone manual processes
Survival Tactic – Automate data collection and tax calculation
Often, there are many manual processes involved between collecting fuel transaction data and producing a signature-ready motor fuel tax return. Back-office systems may not be designed to export or report on fuel transactions in a way that is conducive to excise tax filing. Growth through acquisition often results in multiple back-office systems supplying input data. The need to collect data, aggregate and normalize data from multiple sources usually requires the use of homegrown spreadsheets or manual data entry to file tax returns.
These manual processes expose tax filers to errors. Any time a tax preparer is manually keying, copying, or pasting information, errors can be introduced, increasing the risk of non-compliance, and associated interest and penalties. For example, the Florida Department of Revenue will assess a penalty of up to $200 for incomplete reports. For failure to file, they will assess 10% of unpaid tax. An additional 10% is assessed for each month that taxes are late, and a failure to report tax will lead to license revocation.
Tax filing automation can alleviate the worries of manual processing errors. By eliminating manual steps between transaction capture and filing, opportunities for errors are reduced. When aggregating data from multiple systems, it is important to automate data validation and error handling to ensure the information submitted to taxing authorities is correct.
Challenge #4 – Over-reliance on internal motor fuel tax experts
Survival Tactic – Capture and maintain rules, rates, and forms in a database
As illustrated in the introduction scenario, depending on a single internal expert for understanding tax requirements and internal business processes presents a risk. Cross-training may reduce the chances that taxes won’t be filed on-time and accurately, but the backup resource is only as good as their training. If there are knowledge gaps in your primary tax preparer’s training, that will be replicated to the backups.
Just because an internal expert has a list of tax regulations does not ensure an understanding of how and when to apply them. Blending fuel components, for instance, can have rate variations based on the percentage contribution of multiple input products. Late loads, split loads and diversions can further complicate your tax calculations. Even if your business only files in one or two states, individual county and city jurisdictions may have their own set of laws and environmental fees.
In order to reduce dependency on a single expert and maintain an accurate audit trail, both the month’s filings and the applicable rules, rates, and forms should be maintained in a database. Audits can occur and amendments can be requested from a jurisdiction months, and sometimes years after the original submission, creating a need to retrieve of past information from data backups or to request it from a third-party filing service.
Challenge #5 – Electronic tax filing mandates
Survival Tactic – Automate motor fuel tax filing
While some taxing authorities will still accept physical paper returns, the trend today is electronic filing of motor fuel tax returns and reports. Tax departments in the fuel industry must be prepared to conform to the state requirements for eFiling with sometimes as little as 30 days advance notice. Once a state has mandated eFiling, whether it is in the form of EDI, XML, text or a spreadsheet calculator, this becomes the only acceptable method of filing. Over half of the states currently mandate electronic filing, and several others provide the option for voluntary electronic filing. With the cost and audit advantages available to jurisdictions with eFiling and automated return processing, filers should expect this trend to grow.
In order to conform to an eFiling mandate, taxpayers need software that automates the creation and submission of files which adhere to the required format. If the taxpayer is unable to create and submit their return in the required state format, they will be out of compliance, and at risk for penalties, interest and even license revocation. In the state of North Carolina, unfiled eFile returns are subject to a penalty of 5% per month, with a maximum of 25% of the tax due. A penalty of $50 is charged for informational returns that are not filed electronically.
Challenge #6 – Ensuring audit preparedness
Survival Tactic – Capture tax details for each transaction, including applicable rules and rates
If the above challenges are not addressed, there is a good chance that you will receive a knock on your door from a state or federal auditor. Auditors will often sample tax return details evaluating a variety of items with tax consequence. Reported inventories, purchases, sales, exempt sales, imports into and exports out of their state, and blending activity are some of the items that could be examined. While maintaining these records in a paper format may be acceptable, the auditor will likely require copies of reports that summarize the detailed data on a monthly, quarterly, and annual basis.
Typically, states require a minimum record retention period of 3 years and in some cases 10 years. If paper records are allowed, tax departments often maintain these records in file storage for the required retention periods. If the required records can’t be located, additional penalties may apply.
Using tax automation services will relieve you of the immediate demands of producing audit information. By using pre-defined queries or ad-hoc searches, tax departments are able to provide required information to auditors easily, including both the tax return details and the rules and rates used in their calculation. By leveraging these capabilities and providing the data accurately and efficiently, a company can maintain audit trust and ensure continued compliance.
Challenge #7 – Tax process organizational ownership
Survival Tactic – Tax software using the Software-as-a-Service (SaaS) model
Responsibility for tax accuracy or filing mistakes is often not clear. The tax manager may sign the returns, but if their systems and data are not correct then neither are their taxes. If you use software installed on your own systems, there are a number of problems that can render your results inaccurate. It is vital that such systems are kept up to date with the latest tax content (i.e. rate, rule, and form) updates, as well as software release changes. For larger companies, IT departments must implement and rigorously execute change management processes to acquire, test, and deploy tax software changes quickly and accurately. For smaller companies, the tax preparer may be responsible for tracking changes and keeping their system running smoothly.
A better option for companies of all sizes is the adoption of Software-as-a-Service (SaaS) tax software, which eliminates the need for internal IT involvement in the system and tax content update process and puts tax managers fully in charge of tax accuracy and compliance.
Tax authorities are actively looking for creative ways to address tax revenue reductions, including rule changes, rate increases, new types of taxes, and increasing audits. As a result, motor fuel tax laws and rates will continue to be volatile for the foreseeable future, and tax departments need to be prepared with an agile solution that can handle these anticipated changes.
The key to managing all the complexity and moving parts in the motor fuel tax compliance process is tax automation. Tax automation enables tax departments to:
- ensure compliance with the latest rules, rates, and forms
- track licenses and exemption certificates accurately
- reduce errors through automated data collection and tax calculation
- reduce reliance on internal tax and process experts
- enable compliance with eFiling mandates
- be prepared for auditstake full ownership of tax accuracy and compliance
With an automated fuel excise tax solution, the next time your auditor throws some tough questions at you, you’re prepared for it with all of your filing history in one secure location. As you print the requested reports, you’re thinking, “This is great! I will be done in no time!” As your auditor reaches across the desk for the reports, they’re thinking, “This is great! I will be done in no time!” Suddenly ‘Smiling Auditor’ is no longer an oxymoron.
Avalara provides on-demand fuel management, tax automation, and compliance solutions for suppliers, distributors, buyers, and traders of petroleum products and other energy commodities. Avalara’s solutions deliver operational and financial value to over 650 customers. These customers include leading global oil companies, international retailers, shippers and government entities. Avalara’s fuel management solutions help customers manage the complexity, regulation and market volatility for more than 22 billion gallons of gasoline and diesel fuel annually. Its Excise solutions ensure compliance and accuracy for tens of billions of dollars of energy-related excise taxes per year.