Taxes can be a big burden on a small business bank account. But sometimes, you can receive a refund on your tax liabilities. If your business pays more taxes than owed, you might need to record a journal entry for income tax refund money.
Business structures that make a journal entry for income tax refund money
You receive a tax refund when you pay more taxes throughout the year than what was due on your return. The government owes you the extra money you remitted.
Your business structure plays a big part in whether you need to record a journal entry for income tax money. Certain business entities do not need to record tax refunds.
If the entity uses a pass-through tax, business income is taxed on your individual income tax return. Pass-through tax entities don’t directly pay taxes to the government. Instead, you pay taxes on business profits with your personal tax return, along with any other income you earn.
The following business structures use a pass-through tax system:
- Sole proprietorships
- S corporations
As a pass-through tax entity, your business never receives a refund. You can receive a tax refund on your personal tax return, but you do not need to record it in your books.
C corporations are the only entities that pay income tax directly to the government. A C Corp could receive a tax refund if the business pays more tax during the year than the amount due on the tax return. If your C corporation gets a tax refund, you need to make an accounting entry for tax refund money received.
Ways to get a tax refund
Usually, taxes are a cost to your business. When you owe taxes, you show them as liabilities on the balance sheet until you pay them.
When the government owes you a tax refund, taxes are recorded as receivables (an asset) on the balance sheet. The following are common reasons your business might receive a tax refund.
Some businesses can receive tax credits. A tax credit reduces your tax liability. For example, if you owe $1,000 in federal taxes and are eligible for a $500 tax credit, you only owe $500.
Certain tax credits are refundable. You could receive the amount of the credit even if you did not have to pay taxes. So, if you received a tax credit for $1,000 but you only owed $500 in taxes, the government would owe you $500.
Once you earn a tax credit, you record it in your books as taxes receivable. When you receive the refund, record it as income tax received.
Your business might make quarterly or monthly tax payments for the current year. When you remit your small business tax return, the payments you made are applied to the balance you owe.
If you owe more on the tax return than you paid in installments, you will send the government more money. If you owe less on the tax return than you paid, you will receive money for the overpayment. You receive the difference as a tax refund.
How to record a journal entry for a tax refund
You need to keep a few things in mind to record an income tax refund journal entry. Tax refunds are not considered revenue. Using double-entry bookkeeping, you reverse the original entries you made for paying taxes. You can record a journal entry for a tax refund with the following two steps.
1. Record the original entries for the tax payment
When you pay taxes, you need to record the transaction in your books. To show that you paid taxes, use the following debits and credits:
- Debit the income tax expense account
- Credit the cash account
|Income Tax Expense Account||X|
The debit to the income tax expense account increases your expenses. It shows that you paid the tax. The credit to the cash account reduces your assets. It shows that you have less cash after paying the tax expense.
2. Make an accounting entry for tax refund money
Once you receive a business income tax refund, you need to reverse the original entries in your books. You will debit an asset account and credit the originally debited account for the taxes paid.
To show that you received a tax refund, use the following entries:
- Debit the cash account
- Credit the income tax expense account
|Income Tax Expense Account||X|
The debit to the cash account increases your assets. It shows that you received the refund. The credit to the income tax expense account reverses the original entry, decreasing your expenses.
To show that you expect to receive a tax refund in the future, use the following entries:
- Debit the income tax receivable account
- Credit the income tax payable account
|Income Tax Receivable Account||X|
|Income Tax Payable Account||X|
The debit to the income tax receivable account increases your assets. It shows that you expect to receive the refund in the future. The credit to the income tax payable account reverses the original entry, decreasing your liabilities.
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