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How does AvaTax calculate tax?

Overview

I want to know the decision tree of AvaTax to calculate tax. 

Environment

Avalara AvaTax

Resolution

  • There are three steps that AvaTax calculations go through and they are as follows. 
    • Do you have nexus selected in this location? (Based off of origin and destination address)
      • If yes: Continue to next step.
      • If no: Return 0 tax
    • Does the customer have an exemption? (based off exemption number, entity use code, or customer code if using an exemption certificate)
      • If yes: Then the tax returns either 0 or a reduced rate depending on the exemption reason and the rules behind that in the given location. 
      • If no: Continue to next step
    • Is the item taxable? (based on tax code, and item code)
      • If yes: Calculate tax as normal.
      • If no: Return 0 tax
      • Can also have partial rates or other special taxation rules. 
  • If there is no exemption and the Item is taxable then it calculates tax based on the addresses provided.  

 

  • There are three main levels of tax calculation: customer taxability, product taxability, and tax profile.
    • The application of these three levels results in the tax calculation you see in AvaTax, whether that transaction comes from your connector or is directly entered into the Admin Console.
  • This is the minimum required information for an invoice:

  • This gives us all of our three components of integration: customer information, item/product information, and tax profile information.
  • Once the file was imported into the Admin Console, AvaTax would fill in some more information and calculate the tax, and the document would look like this:

  • Below are primary points used in the tax calculation from the invoice:
    • Customer Taxability:
      • First, we have our customer taxability fields: Exemption Number, Entity/Use Code, and (if you have ECMS enabled and are managing certificates in the Admin Console) Customer/Vendor Code.
        • If the customer is flagged as exempt, that will put any sales in that Transaction in the Exempt bucket for applicable Jurisdictions, and no sales tax will be charged on them, regardless of product taxability.
      • Exemption Number: This is a field that, if it is populated with data, exempts the transaction from sales tax entirely.
        • You can’t see the Exemption Number reported in the Document Detail view from the Transactionstab, but it is exposed if you drill into Document Edit Mode.
      • Entity/Use Code: This field associates a customer taxability profile with a transaction.
        • This can be one of the system-set customer taxability profiles (e.g. Retail or Local Government), or it can be one that you have created rules for in the Admin Console.
      • Customer/Vendor Code: This is only a concern if you’re managing exempt customers through the ECMS in the Admin Console.  
        • If the customer code matches an exemption certificate on file, the destination address is in a state listed in the Regions Applicable on a non-revoked certificate, and the transaction falls within the listed date range, the certificate will be applied to the transaction.
        • This application is also contingent on your ECMS settings.
    • Product Taxability:
      • The taxability of the tax codes passed in the destination state determines the item taxability.
        • Similarly, if a code is non-taxable in a given state, the sales are flagged as non-taxable and tax is not assessed.
      • A few codes are pro-rated at different levels of taxability (e.g. half-taxable, or taxable dependent upon the taxability of other items on the transaction).
      • If no tax code is passed, AvaTax assumes that items are taxable in all states, and assigns the system default code of P0000000.
    • Tax Profile:
      • Once the taxability of the customer and items have been established, the sourced rates are applied to the transaction. 
      • First, sourcing is established; some states source some jurisdictions or products at the origin address for intrastate transactions.
      • Then, those addresses are used to pull the appropriate taxing jurisdictions based on your tax profile and nexus designation.
        • Sales tax or Seller’s Use tax is charged depending on your nexus type.
        • Those rates are applied at the line level to your taxable sales.