Each time you charge retail sales tax as a business, you collect it on behalf of several tax agencies. Throughout the year, these amounts add up. But how do you account for these funds? You’ll want to put these amounts in your sales tax payable account until it’s time to send the tax payment in with your business tax return.
You’ll need to consider several factors when handling this accounting element. Whether you’re an established or new business, understanding the basics of sales tax payable is necessary for ensuring the financial health of your company.
This article covers sales tax journal entries, exemptions, and what to consider when collecting sales tax so you can make sure your bookkeeping is in order. Click on any of the links below to jump around:
- Definition of sales tax payable
- How do you record sales tax payable?
- Sales tax payable and journal entries
- Where should you put sales tax payable on a balance sheet?
- What should you consider when collecting sales tax?
Definition of sales tax payable
For your business, sales tax is a percentage of the total amount of sales owed at the end of the year to government tax authorities (based on where your business has a physical presence). Sales tax is also called a pass-through tax because you act as the intermediary between the customer and the state revenue department. As a business owner, you’re required to retain the money throughout the year until it’s time to remit it to the appropriate tax agency.
So, sales tax payable is the account in your general ledger where you record all the sales tax you collect from customers. Since the sales tax payable account holds money that’s owed, it’s considered a liability account. You’ll use the funds in this account to meet your annual sales tax liability.
How do you record sales tax payable?
Regularly entering sales tax payments into your general ledger may seem complicated, but it doesn’t take long to learn how to do it. Try to make entries as soon as possible after sales occur to avoid missing any amounts. Staying current with your or your client’s sales tax payable account can save time and headaches at the end of the year.
The first thing you’ll do is determine the amount of sales tax you have to collect from your customers based on the price of your products or services. For each transaction, you’ll enter the revenue and tax amounts as credits on separate lines. However, the credit to the sales tax payable account is only temporary. Until you remit sales tax to the tax authorities, you must debit your cash account to keep the ledger balanced in the long term.
Sales tax payable and journal entries
Journal entries are the worker bees of accounting, making up the structure of your accounting system. A journal entry is a record of a transaction that’s entered into your general ledger. Each entry holds information including the date, type of transaction, credited or debited amount, and any notes you decide to include. Ideally, journal entries should be used for all transactions that occur in your business.
For sales tax payable specifically, your journal entry will show the amount of sales tax you collect as a credit. You’ll also enter the product or service revenue amount on a separate line. This tax is money you owe, so you will debit your cash account to keep your books balanced.
Where should you put sales tax payable on a balance sheet?
Because sales tax is something you owe, it’s considered a liability on the balance sheet. You use this account to keep track of sales tax collected from customers on behalf of the governing tax authority.
To record your sales tax payable:
- Create a journal entry.
- Debit your cash account for the amount of sales tax you collected on your sales tax payable balance sheet.
- Then, enter two separate journal entries: your sales revenue and the amount of sales tax you collected.
After you pay the amount of sales tax owed:
- Create a journal entry.
- Credit your cash account for the amount of sales tax you paid.
- Then, debit the same amount from the sales tax payable account.
What should you consider when collecting sales tax?
When it comes to sales tax collection, whether for your own business or for a client, you have many details to consider. Most states have sales tax, but the rates may differ greatly. Many cities and counties also have sales tax. Rules apply for what products and services are taxed, what organizations are exempt, and when sales tax must be paid.
You need to be aware of all the taxes you’re responsible for so you have no expensive surprises when it’s time to make required payments to the government. Consider these important factors.
Taxable products and services
The first consideration is whether your business provides a taxable product or service. Products are fairly straightforward. In general, if you’re selling taxable services or tangible personal property (meaning it can be touched), you’ll typically charge sales tax. A computer is a good example of this type of product.
However, digital products may create some confusion. Take software as an example. Some states consider software to be a tangible product—so sales tax applies—while others consider electronic data products to be nontaxable. You will need to search your state’s department of revenue site for specific information related to your products and services.
State sales tax rates
It’s important to know your sales tax burden so you collect enough tax from your customers to pass through later to the government. If at the end of the year you haven’t collected the correct amount from the customers, you will still need to pay the full amount, but it will be coming from your own pocket.
Your state and local governments establish sales tax rates, and they’re counting on you to send every penny owed to them. Find the proper agency you need to work with using a list of state taxation agencies the Federation of Tax Administrators (FTA) has compiled for your convenience.
Organizations that exist as not-for-profit entities are generally exempt from paying sales tax. Public charities, churches, and professional organizations are all examples of sales tax-exempt entities.
Certain industries, such as manufacturing, are also often exempt from sales tax. In this case, if you’re supplying materials to create finished goods, the sale is tax-exempt. Note that these exemptions vary by state, so you’ll need to check your state’s rules.
If your client mentions that they have tax-exempt status, you’re required to create a sales tax exemption certificate and attach it with your copy of the bill of sale for your records. In the event of an audit, you want every transaction without sales tax charged to be accounted for or you run the risk of having your business being required to pay the sales tax.
Collecting and paying taxes on time
Understanding how to collect sales tax and when to remit it is important. The best thing to do is check your state’s department of revenue website to find current state, city, and local tax rates and due dates. You’ll also need to research any other jurisdiction where you have a physical location. If you collected sales tax for an out-of-state transaction or if you’ve made internet sales, you might owe sales tax in other locations.
Refer to your sales tax payable account to know how much sales tax liability you must report on your income tax return. If you’ve been keeping up with your general ledger, you’ll have a journal entry for every transaction and know the precise total you need to send to the state.
Then, at tax time, you’ll fill out a report to send to the state and remit payment for the amount of sales tax you reported.
How to collect and pay sales tax the right way
The process to successfully collect sales tax is to identify relevant state and local sales tax rates and add charges for those amounts to the total sale amount you charge a customer. Then, you’ll prepare a journal entry for each transaction. In it, you’ll note the date, account numbers, notes, and amounts of credits and debits involved in the sales transaction.
From there, you’ll send your sales tax either quarterly or annually. If you feel nervous about getting this process right, though, you might find it useful to have a freelance tax preparer help with your business accounting. The best thing about working with a professional is that they’ll stay abreast of all the business taxes you owe—and even all the deductions you’re eligible to claim.
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