Accounting for sales taxes
/What are Sales Taxes?
A sales tax is a tax imposed on retail goods and services at the point of sale. The tax is collected by the entity selling the product or service to a third party, and is remitted to the applicable government entity at regular intervals.
When is Sales Tax Collected?
Customers must be charged a sales tax on some sales transactions if the local government mandates that sales taxes be collected. In addition, the seller must have nexus in the territory of that government entity . Nexus is the concept that you are doing business in an area if you have a place of business there, use your own vehicles to transport goods to customers, or (in some cases) have employees situated or living there. Having nexus can result in multiple overlapping sales taxes. For example, a company might have to charge customers the sales tax of the city in which they are located, as well as the county sales tax and the state sales tax. If the company does not have nexus where a customer is located, then the company does not have to charge a sales tax to the customer; instead, the customer is supposed to self-report a use tax to its local government.
All accounting software includes a billing feature that allows you to include the sales tax at the bottom of each invoice, after the subtotal of line items billed. When you charge customers the sales tax, you eventually collect it and then remit it to the state government, which in turn pays it out to the various local governments.
How to Account for Sales Taxes
When a customer is billed for sales taxes, the journal entry is a debit to the accounts receivable asset asset for the entire amount of the invoice, a credit to the sales account for that portion of the invoice attributable to goods or services billed, and a credit to the sales tax liability account for the amount of sales taxes billed.
At the end of the month (or longer, depending on your remittance arrangement), you fill out a sales tax remittance form that itemizes sales and sales taxes, and send the government the amount of the sales tax recorded in the sales tax liability account. This remittance may take place before the customer has paid the related invoice. When the customer pays for the invoice, debit the cash account for the amount of the payment and credit the accounts receivable account.
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What if the customer does not pay the sales tax portion of the invoice? In that case, issue a credit memo that reverses the amount of the sales tax liability account (and which is also a reduction of the accounts receivable asset account). It is quite likely that you will have already remitted this sales tax to the government, so the customer's non-payment becomes a reduction in your next sales tax remittance to the government.
Example of Sales Tax Accounting
ABC International issues an invoice to Beta Corporation for $1,000 of goods delivered, on which there is a seven percent sales tax. The entry is:
Following the end of the month, ABC remits the sales taxes withheld to the state government. The entry is:
| Debit | Credit | |
| Sales tax liability |
70 | |
| Cash |
70 |
Later in the following month, the customer pays the full amount of the invoice. The entry is:
| Debit | Credit | |
| Cash |
1,070 | |
| Accounts receivable |
1,070 |
Other Sales Tax Issues
When a company bills its customers for sales taxes, those sales taxes are not an expense to the company; they are an expense to the customers. From the company's perspective, these sales tax billings are liabilities to the local government until remitted.
It is quite common to have a separate sales tax liability account for each state. If a company operates in multiple states, having a separate account for the sales taxes collected for each one makes it much easier to make remittances. It also reduces the work required to justify the company's remittances in the event of a sales tax audit.