When you sell goods to customers, you likely collect and remit sales tax to the government. Likewise, when you purchase products, you typically pay sales tax. But, how do you record these tax collections and payments in your accounting books?
Understanding sales tax accounting is an important part of maintaining organized and accurate records. Read on to learn how to record sales tax in your books.
About sales tax
Sales tax is a pass-through tax tacked onto consumer purchases. As a pass-through tax, you must remit collected sales tax to your state or local government. You do not pay sales tax when customers buy from you—customers pay sales tax. But, sales tax is not part of your business’s profits.
When you buy goods that are subject to sales tax, the seller collects the tax from you. They then remit it to the proper government.
How do you calculate sales tax? Sales tax is a percentage of a consumer’s total bill. The percentage you collect from customers varies based on what state, county, or city your business has a physical presence in.
The majority of states impose sales tax, but there are some exceptions. Alaska, Delaware, Montana, New Hampshire, and Oregon do not have a sales tax. However, there might be local taxes imposed in these states.
Some goods, like raw materials, are not subject to sales tax. If you sell raw materials to another business that then sells them to customers, you generally won’t collect sales tax from the business. That business will collect sales tax from its customers.
If your business has a physical presence in a state with a sales tax, you must collect sales tax from customers. Then, you must record the collected sales tax in your books. If a seller charges you sales tax, you must record the sales tax expense in your books.
Sales tax accounting
Sales tax accounting is the process of creating journal entries to record sales tax you collect and pay. Your sales tax journal entry depends on whether you are collecting sales tax from customers or paying sales tax to vendors.
Sales tax accounting—customer sales
Collected sales tax is not part of your small business revenue. When you collect sales tax from customers, you have a sales tax liability. You must remit your sales tax liability to the government. As a result, collected sales tax falls under the liability category.
Liabilities are increased by credits and decreased by debits, as shown in this chart:
For organized records, create a Sales Tax Payable account. This represents sales tax money you collected from customers but have not yet remitted to the government. You owe this money to the government.
When you collect sales tax from customers, you increase the corresponding liability account, which is your Sales Tax Payable account. And because you collect the sales tax, you also must increase your Cash account. Your Cash account is increased by debits.
Because sales tax is lumped into the total amount your customers pay, you will include the sales tax as part of the total sales revenue in your accounting books, too. To do this, credit your Sales Revenue account.
To record received sales tax from customers, debit your Cash account, and credit your Sales Revenue and Sales Tax Payable accounts.
Your sales tax journal entry should look something like this:
|X/XX/XXXX||Cash||Collected sales tax||X|
|Sales Tax Payable||X|
When you remit the sales tax to the government, you can reverse your initial journal entry. To do this, debit your Sales Tax Payable account and credit your Cash account. This reduces your sales tax liability.
|X/XX/XXXX||Sales Tax Payable||Remitted sales tax||X|
Let’s say you sell $5,000 worth of goods to a customer, which is subject to a 5% sales tax. First, determine how much sales tax you need to collect.
$5,000 X 0.05 = $250
Collect an additional $250 for sales tax. In total, you must collect $5,250 from your customer. Record both your sales revenue of $5,000 and your sales tax liability of $250 in your accounting books.
To do so, debit your cash account for the total amount the customer paid you. Then, credit your Sales Revenue account the amount of the purchase before sales tax. And, credit your Sales Tax Payable account the amount of the sales tax collected.
Take a look at the following journal entry:
|10/2/2018||Cash||Collected sales tax||5,250|
|Sales Tax Payable||250|
After remitting the sales tax of $250, create a new journal entry to decrease your Sales Tax Payable and Cash accounts:
|10/12/2018||Sales Tax Payable||Remitted sales tax||250|
Sales tax accounting—purchases
When you purchase goods and pay sales tax on those goods, you must create a journal entry. In this case, the sales tax is an expense, not a liability. Generally, your total expense for the purchase includes both the price of the item(s) and the sales tax.
Decrease your Cash account and increase the corresponding expense (e.g., Supplies) account. Because expenses are increased through debits, debit an expense account and credit your Cash account.
Your journal entry should look like this:
You purchase new business supplies for $1,000. The supplies are subject to a sales tax of 4%. Your total bill is $1,040, which includes the amount of the supplies and the 4% sales tax.
To record your journal entry, debit your Supplies account and credit your Cash account:
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This is not intended as legal advice; for more information, please click here.