Why are communications taxes so complex?
Communications taxes can impact a much broader range of services than many businesses realize, leaving unprepared tax teams lurching as they discover they have entered an unfamiliar and much more complex compliance environment. This four-part series will help businesses and tax advisors understand how to first assess, and then minimize, the risks associated with communications tax compliance — before it’s too late.
First, we’ll lay the groundwork for understanding why communications taxes are so much more complicated than most other types of indirect taxation.
What are communications taxes?
Decades ago, communications taxes were applied only to wireline telephone calls. The communications industry expanded over the last several decades to also encompass voice and data over cellular, cable, satellite, fiber, and VoIP networks. Digital content, including streaming audio and video, emerged several years ago, bringing explosive growth but highly varied tax rules. The internet of things (IoT) is once again expanding how we communicate as our homes, businesses, cars, clothing, lampposts — just about any physical object — can transmit data. This further complicates how communications taxes are calculated and puts tremendous pressure on small and medium businesses already struggling to manage complicated tax compliance. It also puts businesses at considerable risk of overpayment or underpayment of taxes, as well as audit penalties and fines.
So, what makes communications tax so hard? The baseline comparison for any tax is to sales and use taxes. Any way you look at it, keeping up with changing tax rules and forms in thousands of jurisdictions is no easy task. Managing sales tax has its own web of intricacies and complex nexus requirements made increasingly more difficult by the South Dakota v. Wayfair decision. However, communications tax calculation is much more nuanced. It is not one simple calculation, but a complicated web of difficult to define calculations. And as a heavily regulated industry, the volume and complexity associated with preparation, filing, remittance and reporting processes can be overwhelming for the communications sector.
Understanding the biggest challenges
To minimize risk, tax advisors must first understand the layers of communications taxation complexity before they can begin to ensure compliance.
- Difficult sourcing. Correctly determining a customer’s location to calculate tax is critical to avoiding audit risks, penalties, overpayments and lost revenue. However, making this determination can be complicated, particularly with wireless and VoIP services because by nature these are not fixed locations.
- Bundle management. Bundling multiple services, or services along with a product, can lead to a mix of tax rates. It is important to build bundles correctly to ensure that all items can be appropriately taxed and reported. In many jurisdictions, this could make a difference in whether the entire bundle may become subject to communication taxes and regulatory fees. Thoroughly understanding these nuances is key to lowering risk and liability.
- Complex calculations. Calculating communications taxes, fees, and surcharges, especially when multiple services are bundled together, depends on complicated mathematical equations. These are complex, sometimes calculated to a fraction of a percent, including tax on tax, self-taxing, tiered taxing, brackets and prorated taxes. Businesses that don’t automate these calculations will almost always encounter a very high error rate.
- Accurate, compliant billing. The ability to produce accurate and compliant billing depends on adhering to several rules and best practices. Bills must follow “truth in billing” requirements as laid out by the FCC. It is also essential to understand what items can, cannot and must be included on a bill, which varies by state. For instance, surcharges, or regulatory fees billed back to the end user, can’t be misleadingly labeled as taxes. There also must be separate billing sections for “taxes” and “other charges and credits.”
Implications for tax professionals
As a tax professional, how can you navigate all this complexity with confidence, particularly in a rapidly changing competitive environment? In subsequent articles, we’ll discuss when businesses might incur a communications tax liability, as well as take a closer look at the intricacies of bundling and its impacts on many aspects of communications tax compliance. We’ll also examine the buzz surrounding 5G IoT, which often has strong cross-over with industries that typically have only sales and use taxation requirements.
In the meantime, if you think you or a client might have a communications tax liability, reach out to an expert to help you make that determination. If communications tax is in the picture, here are the first critical steps you need to take:
- Determine where you have nexus.
- Ensure you can keep up with rate and forms changes in every jurisdiction.
- Make sure bundles are built to stand up to any audits.
- Categorize revenue for easier reporting.
- Ensure all systems are set up for accurate reporting and billing.
For more on communications tax challenges, check out the other articles in this series:
Part 2: Is your client on the hook for communications tax?
Part 3: Managing tax risk when bundling communications services