Benjamin Franklin once wrote, "In this world nothing can be said to be certain, except death and taxes." But how one processes the payment of those taxes is not so certain. In the case of electronic sales tax payments, there are two options that have both a time and a monetary impact: an Automated Clearing House (ACH) credit electronic payment or an ACH debit electronic payment. Which is better? Here is how to choose.
The movement of money and information from one bank account to another in the United States is handled by the ACH Network, which is managed by the not-for-profit electronic payments association NACHA. At the center of 23 billion electronic financial transactions totaling over $40 trillion per year, the ACH Network is one of the largest, safest, and most reliable payment systems in the world.
Payments: ACH Credit vs. ACH Debits
Direct payment via ACH is the use of funds to make a payment. Individuals or organizations can make a direct payment via ACH as either an ACH credit or ACH debit transaction. The differences between these two options are:
- A direct payment processed as an ACH credit pushes funds into a designated account. An example of this is when the user initiates a payment through his or her company's bank to be deposited into a state's bank account to pay a tax bill.
- A direct payment processed as an ACH debit pulls funds from a designated account. An example of this is when the user establishes a payment for a tax bill to be debited from his or her company's bank account by entering his or her company's bank information on a state website.
- With ACH credit, payment batches can be released with any future effective date. This helps the payer manage its bank account because (1) payment batches can be released by due date rather than the next business day; (2) payment batches can be released before funds have posted to the account (this helps with short turnaround (funds in and payments out)); and (3) returns can be filed without payment on state websites, expanding the time frame to get numerous time-consuming filings completed.
- With ACH debit, payments usually have a "next business day" effective date. This is inconvenient for managing a bank account because (1) payments that are released usually default to the next business day on the state-run websites; (2) payments default to the next business day so one must wait until funds are in to begin releasing individually (this helps with a short turnaround time where funds are hitting the account when payments are required to go out); and (3) returns must be filed with payment in most ACH debit cases, shortening the time frame to get both filings and payments completed.
Why Choose ACH Credit Over ACH Debit?
The short answer to this question is effective time management, cost efficiency, and mitigation of risk. Many organizations currently use the ACH debit option primarily because it is the easiest to execute in the short term. The trade-off for ease of use, however, is high risk of error and difficulty reconciling payments.
Individual vs. Batch
ACH debit payments can only be made individually, so not only do they take more time, but there is also more room for error. The websites used for payments sit on a wide range of platforms, and they do not interoperate. Users are forced either to manually key the payment amount, which risks transposition errors, or automatically generate the payment based on the tax return filed, which risks inaccurate return submission and expected payment alignment.
In contrast, ACH credit payments can be automated, dramatically lowering the risk of manual error. ACH credit payments can also be submitted in batches rather than one by one. As such, a company can generate ACH credit batches based on different parameters (i.e., by company, due date, or jurisdiction). This convenience allows tax managers to enter the bank information once for multiple tax transactions to save time and reduce the risk of error, and in a uniform format. It also allows a company to set up bank account information for each vendor just once and link future payments to that vendor automatically. In addition to saving time and effort, this process allows companies to confirm the accuracy of payments prior to their release.
Reconciliation Challenges
ACH debit payments can cause issues with the reconciliation process. There is no guarantee that the amounts paid match to the general ledger or payment summary. When reconciling the bank account, tax managers must tie debit payments to each individual transaction to confirm accuracy, which can be time-consuming. Banks may also impose "ACH debit blocks" on unauthorized transactions. These blocks will result in a canceled payment and late payment fees if not set up in advance with all relevant financial institutions.
ACH credit batches, on the other hand, are easier to reconcile (even prior to submission). They are paid in batches, so rather than making 100 individual ACH debit transactions, a company can release one to five ACH credit batches, organized by due date. By comparing these batches to the expected payment amounts prior to submitting payment, the tax manager can guarantee that the money the jurisdiction received is correct. Further, these same batches will show up on the corporate bank detail, making bank reconciliations far easier.
To create an ACH credit batch, companies need to create an addenda record, the piece of data that tells the taxing jurisdiction what taxpayer, tax type, and payment period the payments cover. Requirements for addenda records vary by state and may not be easy to produce manually, so consider an automated approach such as:
- Microsoft Excel: Formulas and/or macros can easily help automate the monthly process for new or recurring transactions.
- Bank application: Ask your bank if it can provide a module to easily upload transactions each month.
- ACH origination software: Third-party vendor software can be downloaded straight from the internet to help complete the process.
Conclusion
When mapping out the functionality of the two transaction options, the pros of ACH credits outweigh the ease-of-use advantage of ACH debits. The overall benefits are efficiency, cost savings, and lower exposure to risk. See the exhibit below for specifics.
With fewer resources to reduce overall tax liabilities, tax departments must work smarter to balance fundamental activities with new technology, rising costs, and regulatory complexity. Take the time to look at the nuances of long-term and more efficient solutions to monthly transactions that are otherwise taken for granted, to find innovative and better ways to execute.
EditorNotes
Howard Wagner is a director with Crowe Horwath LLP in Louisville, Ky.
For additional information about these items, contact Mr. Wagner at 502-420-4567 or howard.wagner@crowehorwath.com.
Unless otherwise noted, contributors are members of or associated with Crowe Horwath LLP.
