Avalara Whitepaper - Business Solutions for Tax Compliance

ZIP codes don't mean zip for ecommerce sellers

Pinpoint risk in your online business with geolocation technology

“Can I have your ZIP code, please?” Seems like a simple enough request. But if you are a retailer asking this from a customer, you could be in for trouble. 

ZIP codes are the default method used by merchants to verify a customer’s information for authenticating payment, applying sales tax, and shipping items. The problem is that it’s not always accurate—or even legal.

Recent consumer-instigated lawsuits claim that retailers are going outside the scope of “verification” and using ZIP codes to market to them without their consent. To address this, more than a dozen states, including Massachusetts and California, have enacted laws preventing retailers from asking customers to provide personal information, including ZIP codes, at the time of checkout.1

This may be a blow to bricks-and-mortar stores looking to capitalize on the demographic DNA found in ZIP Code data. But how does it impact ecommerce?  Asking for a ZIP code in an online sale isn’t unlawful, but neither is it particularly useful. In fact, instead of helping you make the sale, ZIP code verification can actually detract from your bottom line.

A five-digit code for fraud 

Retailers lose an estimated 5% of their annual revenues to fraud ever year, according to the Association of Certified Fraud Examiners (ACFE). Last year, this loss totaled $3.5 trillion globally. Ecommerce and mobile commerce merchants take the biggest hit, according to LexisNexis, due to the prevalence of card-not-present (CNP) transactions for online sales.

CNP transactions pose a risk to sellers because they cannot directly verify the cardholders’ identity. This has also led to a sharp rise in fraudulent transaction attempts—up 61% over last year.2 Merchants also assume the risk for CNP sales, not the card issuers. Some credit card companies even charge higher transaction fees on CNP purchases.

To mitigate the risk of card fraud, most U.S. merchants use Address Verification System (AVS) to authenticate online sales. More than 75% of sellers employ this practice according to CyberSource.  AVS uses a combination of the street address and ZIP code to verify the transaction; the premise being that an unauthorized user would not have access to the legitimate cardholder’s billing address.

This pretense has proven problematic. There are a number of valid reasons why ZIP code authentication might fail including incorrect or outdated information. In fact, The Fraud Practice estimates that AVS inaccuracies can impact as much as 28% of a merchant’s legitimate orders. And with how easy it is to find information on the Internet today, it wouldn’t be hard for a fraudster to get the cardholder’s address and clear the AVS security hurdle.

Veering off course in compliance

ZIP codes are often the default tool used by sellers to determine sales tax rates as well.  However, taxing jurisdictions don’t always follow ZIP codes. Tax rates can even vary even within an individual ZIP code. Greenwood, Colorado is a great example. If you’re a business with a taxable sale in Greenwood and use a generic ZIP code look-up tool to find the correct sales tax rate, you’d enter the address and ZIP code 80111 and get the sales tax rate of 7.72%. However, while Greenwood has one ZIP code, it has four different sales tax rates. So there’s a high degree of probability that you’ll get the rate wrong. Often counties and municipalities levy additional sales taxes on top of state rates. ZIP code tools can’t account for these variances.

Getting sales tax right may not seem like a big deal for ecommerce companies, but it is. Mores states are now requiring online sellers to collect sales tax and auditors are on high alert for businesses who are failing to comply. It’s also highly likely that, as an ecommerce merchant, you engage in affiliate marketing, fulfillment programs, drop shipping or other nexus-creating activities that require you to collect and remit sales tax. And the faster your business grows, the more complex sales tax becomes, and the harder it is to be compliant. Every time you sell into a new state, depending on nexus, you have to track even more rates, rules, and boundaries and register, file, collect and remit sales tax.

Given how frequently ZIP codes, tax rates and jurisdictions change, this is no easy feat. According to the U.S. Postal Service, more than 25,000 changes are made to 5-digit ZIP Codes on a monthly basis. Additionally, there were more than 14,000 changes to sales tax rates and taxing jurisdictions in 2014.3 Relying on ZIP codes to calculate sales tax rates is akin to chopping down a tree with a pen knife.

Improperly managing sales tax can also affect customer service. Unexpected charges at checkout is the top reason online shoppers abandon a purchase.4 This includes sales tax. Overcharge customers and you risk them walking away from the sale and from you.

Zeroing in on what works

Geolocation technology is much more precise than ZIP codes in both verifying online sales and in ensuring accurate sales tax calculation.

For online transactions, IP Geolocation is now being used by 42% of merchants.5 IP Geolocation pinpoints the exact location of the computer or mobile device where the order originated and returns a “risk score” based on how close this location is to the buyer’s shipping or mailing address. If the order is suspect, the merchant can deny the transaction or employ additional authentication measures to verify the sale. Geolocation technology can also identify highly suspect activity such the use of proxy servers, orders placed from international IP addresses, P.O. boxes or drop shipment forwarding address and untraceable email ISP addresses. Additionally, AVS using ZIP codes is limited to U.S. sales; geolocation technology can be used to verify international transactions as well.

Geolocation is also a much more accurate method of determining sales tax rates. It works much like a GPS system, using geospatial mapping technology to pinpoint a location, in this case the buyer’s address, match it to the relevant taxing jurisdiction, and calculate the sales tax rate “down to the rooftop” using exact longitude and latitude coordinates.

Employing an automated sales tax solution in your ecommerce system or shopping cart that uses geolocation technology to verify addresses and tax rates will ensure the right rate is calculated, in real time, for every taxable transaction. This is a best practice that states (and state auditors) appreciate—as will you when you don’t have to worry about an audit. Using geolocation for sales tax also improves conversion rates and customer service. Buyers always know the sales tax up front when placing an online order and address verification for invoices and shipping notices ensures timely delivery.

No margin for error

As the online marketplace continues to heat up, sellers will need to adopt more sophisticated solutions to ensure transactional integrity without slowing down sales. Swapping out primitive tools like ZIP codes for tech-savvy solutions like geolocation is a step in the right direction. Choose a provider with a proven track record in using geolocation technology and that will integrate easily into your ecommerce system so you can get up and running quickly and ensure a seamless transition.

Ready to get real about online sales risk?

Avalara is spot on when it comes to compliance. Our AvaTax sales tax automation software precisely calculates rates, rules and boundaries for all your taxable transactions in real time. And we integrate with 300+ of the most widely used ecommerce, ERP, POS and accounting systems. Learn more.

1The Boston Globe, Creditcards.com

22014 LexisNexis Trust Cost of Fraud Study



5CyberSource 2014-2015 Online Fraud Management Benchmark Study

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