The Basics of Sales Tax Accounting
What is Sales Tax?
Sales tax is imposed on the prices of certain goods and services. The tax is a percentage of the sale price of a product and is collected at the time of purchase. The amount of sales tax varies by city and state. Since different states have different sales tax regulations, most businesses have separate liability accounts for each state when accounting for sales tax.
Do I Have to Collect Sales Tax?
The short answer to that question is, “maybe.” Most states have sales tax on certain goods and services. If you sell physical products or offer services that aren’t exempt from sales tax, then you’ll likely have to collect sales tax. It’s worth checking the regulations for your state so you understand how much sales tax you must collect if any.
If your business holds a presence in multiple locations, then you may have to collect sales taxes for outside states. Check every state you sell goods and services to understand how they define out-of-state and nexus sellers. For example, in Ohio, any business with at least 200 transactions or collects over $100,000 in gross sales must collect sales tax, even if they don’t have physical premises.
How to Account for Sales Tax?
Given that businesses collect sales tax on behalf of the authorities, they don’t get to keep any of it, so it isn’t recorded as revenue.
For example, if you sell something worth $100 and have a 10% sales tax, you’ll separate the tax from the gross sale. Here’s how you’d calculate the sales tax for this purchase and others:
Sales Tax = Total Sales x Sales Tax Rate
In this case, it would be: 100 x 10/100 or 10. You debit the transaction at $110, crediting sales for $100 and sales tax payable for $10.
What is the Journal Entry for Sales Tax?
Sales tax journal entries are entered as a debit to accounts receivable or cash account for the entire amount of cash received, a credit to sales accounts, and a credit to sales tax payable accounts.
Broken down, a journal entry for sales involve sale tax are as follows:
|Credit||Sales Tax Payable|
After remitting the sales tax, you add a debit to the Sales Tax Payable account and credit the Cash account to balance the books.
If your business purchases goods and services from vendors and pays a sales tax for those items, it charges the sales tax to expenses for the current period. Paying sales tax yourself is an expense but receiving sales tax on goods you sell isn’t income.
Is Sales Tax Recorded as an Expense?
Knowing how to account for sales tax begins with knowing how to record it in your books. Businesses act as collection agencies by charging a sales tax. The business then remits the government after collecting said sales tax. This means the business reduces its cash and sales tax liability.
In that case, a sales tax isn’t an expense, and it isn’t a part of business income. From a business standpoint, sales tax is a liability to the government until remitted.
Sales Tax Accounting Method Example #1
Showing is often better than telling, so let’s look at an example of a fictitious company and how they would record sales and collect/remit sales tax in their books.
The journal entry examples from general ledger accounts can be used for manual accounting systems or put into accounting software such as QuickBooks.
- Journal Entry Example One
Suppose Company A sells $100.00 worth of goods to a customer with a 10% sales tax. The journal entry would look like this:
|Sales Tax Payable||$10.00|
In this case, the customer buys $100 of products from Company A, which collected $10 of sales tax. The company received $110 from the customer. The money is placed in the Cash account or Accounts Receivable, depending on how the customer paid.
Here’s how it breaks down:
- You debit assets to increase them, meaning that you increase Cash/Accounts Receivables when you make the sale;
- You credit revenue and liability accounts to increase them, meaning you increase the Sales Revenue account with the total sale minus sales taxes. The sales tax goes into the Sales Tax Payable account.
Company A remits the collected sales tax to the appropriate government body at the end of the month, completing their role in the process.
- Journal Entry Example Two
|3/16||Sales Tax Payable||$500.00|
In this example, Company A filled out a sales tax remittance form to itemize the sales and sales tax for the month. The company sent the government the collected sales tax recorded in the account, including the initial $10 from the first example.
Sales Tax Accounting Method #2
Some small business owners choose not to separate sales tax and revenue or are unable to do it. If that happens, you need an extra journal entry to move the sales taxes from the Sales Revenue into the sales tax payable account. Here’s what that looks like:
- When you sell the product
- When you determine the owed sales tax
|Sales Tax Payable||$10.00|
As with the first method, when it’s time to remit the collected tax or file the sales tax to the government, you make another journal entry. It represents taking the money out of the sales tax payable account and decreasing cash to balance the books.
What Type of Account is a Sales Tax Payable Account?
Sales tax taken from customers becomes a liability for the business when collected. The Sales Tax Payable account is a liability account on the balance sheet used to keep track of collected sales tax taken from customers. The business holds the money and is liable for remitting it to the government.
Given that different states have different tax rates and apply sales tax to different goods and services, you should start by determining where sales tax applies to your inventory. What do you offer that needs sales tax added to it? From there, calculate the sales tax rate, check for any exemptions, and collect sales tax as appropriate to pay the state.
Sales tax is applied to certain purchases according to the local and state government. Businesses collect sales tax on behalf of the government and then remit the money at an appropriate time. Ensure your business properly accounts for sales tax and makes timely payments to stay out of financial trouble.