How to calculate sales tax
/What is Sales Tax?
Sales tax is a consumption tax imposed by the government on the sale of goods and services. It is usually calculated as a percentage of the purchase price and collected by the seller at the point of sale. The seller is responsible for remitting the collected sales tax to the appropriate tax authority. Sales tax rates and regulations vary depending on the country, state, or local jurisdiction.
How to Calculate Sales Tax
The following steps show how a seller would calculate sales tax.
Step 1. Determine Whether Nexus Exists
Nexus is when you have a place of business within the boundaries of a government jurisdiction, or use your own vehicles to transport goods there, or send your employees into that area on business. Economic nexus may also be present, where your sales into a state exceed a certain threshold level.
Step 2. Set Up the Sales Tax Percentage
If there is nexus, set up the appropriate sales tax percentage in the database record of the customer for which you want to record a sale. This may include the compilation of separate sales tax percentages for the applicable state, county, city, and special taxation district. For example, if the state tax is 4%, the county tax is 1% and the city tax is 2%, then the grand total tax charged to the customer will be 7%.
Step 3. Set Flags for Exempt Customers
If a customer is exempt from sales taxes, make sure that it has sent a valid sales tax exemption certificate. Then create a flag in the database record of the customer that no sales tax is to be charged to it.
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Step 4. Create an Invoice
Create an invoice to document the sale to the customer. The software should automatically pull the applicable tax rates from the database record for the customer and apply it to the total of all items listed in the invoice. If some customer purchases are exempt from sales taxes, flag these items on the invoice, and verify that the calculated sales tax does not include it.
Step 5. Record the Sales Tax Liability
Record the sales tax liability in the accounting records. If you sent an invoice to the customer for later payment, the entry is a debit to the accounts receivable account and a credit to the liability account for sales taxes payable. If the customer paid in cash at the point of sale, the entry is a debit to the cash account and a credit to the liability account for sales taxes payable.
Accounting for Sales Taxes
If you want to also record the eventual remittance of sales taxes to the applicable government authorities, record a debit to the liability account for sales taxes payable and credit the cash account.
Sales Tax Processing Best Practices
In order to receive updates on the correct sales tax percentages, file to do business with the various governments in whose jurisdictions the company has nexus. It may be sufficient to file to do business at the level of the applicable state government.
If you are remitting sales taxes to multiple government authorities (as will be the case when there is nexus in multiple states), establish a different sales tax liability account for each government jurisdiction to which you are remitting sales taxes. Otherwise, it will be very difficult to calculate payments to each jurisdiction.