What expense category is Avalara Expenses?

Navigating the complexities of sales tax, VAT, and other transactional taxes can be a significant challenge for businesses of all sizes. Services like Avalara offer automated solutions to help manage these tax compliance obligations. For accountants and Small Business Owners (SMBs), correctly categorizing expenses related to Avalara is essential for accurate financial statements, sound budgeting, and adherence to tax laws. This guide will delve into how Avalara expenses are typically classified, their tax implications, and how Fyle can help streamline their management.

What are Avalara Expenses?

Avalara is a company that provides cloud-based software and services for automating tax compliance. Businesses use Avalara for a variety of functions, including:

• Calculating sales tax, VAT, excise tax, and other transactional taxes in real-time.
• Managing sales tax exemption certificates.
• Preparing and filing tax returns across various jurisdictions.
• Remitting taxes to the appropriate authorities.

Avalara expenses, therefore, are the costs incurred by a business for subscribing to and utilizing these tax compliance automation services. These are generally incurred to ensure the business meets its legal obligations regarding transactional taxes, reduce audit risk, and improve operational efficiency in tax management.

How to Classify Avalara Expenses for Accounting and Tax Purposes

Avalara's services are typically delivered through a Software-as-a-Service (SaaS) model, involving recurring subscription fees. Here’s how to approach their classification:

Operating Expense – Software Subscription or Tax Compliance Service

• Payments for Avalara services are most commonly classified as software subscription expenses due to the nature of the platform.
• They could also be categorized under a more specific heading like Tax Compliance Software/Services, or as part of Professional Fees (specifically for tax-related services), or within broader categories like Office Expenses or General and Administrative Expenses in your chart of accounts.
• These are costs associated with the ongoing operations of the business and are generally treated as operating expenses.
• For an expense to be tax-deductible, it must be both ordinary and necessary for conducting your trade or business. An ordinary expense is common and accepted in your industry, while a necessary expense is helpful and appropriate. Services like Avalara, which help with mandatory tax compliance, generally meet these criteria.

The 12-Month Rule for Prepaid Subscriptions

• If your business pays for Avalara services annually to potentially receive a discount, IRS rules for prepaid expenses apply.
• Generally, you cannot deduct expenses paid in advance if they create an asset whose benefit extends substantially beyond the end of the current tax year.
• However, an important exception, often called the "12-month rule," states that you do not have to capitalize amounts paid for creating an intangible asset (like a prepaid service/software subscription) if the right or benefit created does not extend beyond the earlier of:

1. 12 months after the date you first receive the right or benefit, OR
2. The end of the tax year following the year in which you made the advance payment.

• For a cash-method taxpayer, an annual Avalara subscription can generally be deducted in the year it's paid if it meets this 12-month rule.
• For an accrual-method taxpayer, expenses are generally deducted when the all-events test is met (liability is fixed and determinable) and economic performance occurs. For a service like Avalara, economic performance typically occurs as the service is provided over the subscription term, leading to the expense being recognized ratably over that period.

Distinction from Custom-Built or Purchased Software:

• Avalara's services typically consist of subscriptions for using their existing cloud platform. This is different from a scenario where a business might pay a large, one-time fee to develop or purchase custom tax software that it then owns.
• If software were purchased outright (and not acquired as part of a business acquisition), and is readily available for public purchase, not substantially modified, it would generally be capitalized and depreciated over 36 months (unless eligible for Section 179 expensing or special depreciation allowance).
• However, since Avalara provides a service via its platform, the subscription fees are typically expensed as incurred or over the subscription period as per the 12-month rule and the taxpayer's accounting method.

Examples of Avalara Expenses

Common expenses associated with using Avalara services include:

• Subscription fees for core products like AvaTax (for tax calculation).
• Fees for Avalara Returns (for preparing and filing tax returns).
• Charges for Avalara Exemption Certificate Management.
• Fees are based on the number of transactions processed or the number of jurisdictions (states/countries) covered.
• Costs for add-on modules or integrations with e-commerce platforms, ERPs, or accounting systems.
• Implementation or setup fees, if any (these might sometimes require separate consideration for capitalization if they provide a distinct long-term benefit, though typically they are part of the overall service cost).

Tax Implications of Avalara Expenses

Deductibility:

Fees paid for Avalara services, used for managing your business's tax compliance obligations, are generally tax-deductible as ordinary and necessary business expenses. This includes costs related to sales tax determination, return preparation, and other compliance activities. The cost of preparing the business-related part of your tax returns is a deductible business expense.

Timing of Deduction:

• Cash Method: Businesses using the cash method of accounting generally deduct these expenses in the tax year they are paid. For an annual subscription, the full amount can often be deducted in the year of payment if it adheres to the 12-month rule previously discussed.
• Accrual Method: Businesses using the accrual method generally deduct expenses when they are incurred (all-events test met and economic performance occurs). For an annual Avalara subscription, this usually means allocating the expense over the subscription period.

Recordkeeping:

• It's crucial to maintain thorough records of all Avalara expenses. Supporting documents should clearly show Avalara as the payee, the amount paid, proof of payment, the date the expense was incurred/paid, and a description of the services received.
• Essential records include:

• Invoices and service agreements from Avalara.
• Credit card statements or bank statements reflecting the payments.
• Canceled checks or proof of electronic funds transferred.

These records are vital for substantiating the deductions claimed on your tax return.

Automating Avalara Expense Tracking with Fyle

Managing recurring expenses like Avalara subscriptions requires careful tracking. Fyle can help automate this process, ensuring accuracy and efficiency:

E-receipt Management: 

Avalara typically provides invoices and payment confirmations electronically. Fyle users can forward these e-receipts from their email (Gmail, Outlook) directly to Fyle, where they are automatically parsed and attached to the corresponding expense entry.

Automated Categorization & Coding:

Fyle’s system can be set up with rules to automatically categorize Avalara expenses under the appropriate account, such as Tax Compliance Software or Software Subscriptions, and assign the correct GL codes imported from your accounting system.

Credit Card Reconciliation: 

If Avalara fees are paid with a company credit card linked to Fyle, real-time transaction feeds can instantly bring in the payment data. Fyle can then automatically match this transaction data with the uploaded invoice from Avalara, streamlining the reconciliation process.

Seamless Accounting Integration: 

Fyle provides robust, 2-way integrations with leading accounting software like QuickBooks Online/Desktop, NetSuite, Xero, and Sage Intacct. This allows for the automatic export of categorized and coded Avalara expenses as bills, journal entries, or credit card charges, reducing manual data entry and ensuring your books are always up-to-date.

Spend Visibility and Budgeting: 

Fyle’s dashboards offer real-time visibility into all company spending, including subscriptions for services like Avalara. This helps accountants and business owners monitor costs, track against budgets, and analyze spending patterns for better financial control.

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By utilizing Fyle, businesses can effectively manage their Avalara expenses from receipt to reconciliation, ensuring accurate financial records and simplified compliance.