Sales Tax Journal Entries: Income, Expense or Payable?

Is sales tax collected considered income?

Sales tax you collect is not income when a state or locality imposes it on the buyer and you must collect it and pay it over. IRS Publication 334 says that tax is not income, stays out of gross receipts and sales, and cannot be deducted. It passes through your books: you record it as a liability, money you owe the state, when you record the sale, then clear that liability when you pay.

Check three things before you rely on that rule:

• Who the tax is imposed on. Publication 334 treats a tax imposed on you as the seller differently, and some states, such as New Mexico and California, word their tax in a way that may put it on that side. See the seller-imposed section below.
• How past entries were made. If payments to the state were booked as expenses, or collected tax was booked as sales, the profit and loss statement may be off for every year since, and an income tax return filed from those books may be too. If that has run a year or more, see the fix section and Different for you? below.
• What posts the tax for you. A sales tax feature may post tax to a payable on its own, while a bank feed line or a hand entry may not. Open the profit and loss statement: it should show no line for tax collected from customers. The balance sheet should carry the tax charged and not yet paid in a sales tax payable account.

The rule covers tax you were required to collect. Tax charged in error, or where you had no duty to collect, is not covered by that sentence in Publication 334; a professional should settle how it is booked and reported.

Gather the filed sales tax returns, the payment confirmations, the sales tax payable detail by period, and the profit and loss statement for each year in question.

A Form 1099-K amount can include sales tax, so it may not equal your income (Publication 334). See reconciling sales and payouts.

What is the sales tax accounting journal entry for a sale?

Record the price as sales and the tax as a liability. Debit cash or accounts receivable for the full amount the customer owes, credit sales for the price, and credit sales tax payable for the tax.

Show the tax on its own line on the invoice. New York requires the tax stated separately on any receipt or invoice you give a customer. Texas requires it too, unless you give a written statement that tax is included in the price and post a sign saying so. When a price includes tax, Texas gives the split: the sales price is the total divided by one plus the tax rate, and the rest is tax.

New York, for one, requires a seller to report tax for the period of the sale, whether or not the customer has paid, even if the books are cash basis, apart from a pay-when-paid option for suppliers of building materials that a separate bulletin sets out (Publication 750, 11/15 edition). Where that is so, cash-basis books show a different payable than the return. See a payable that does not match the return.

Should I enter sales tax as an expense every time I pay the state?

No, not for tax you collected from customers. Paying the state clears the liability: debit sales tax payable and credit cash. The profit and loss statement is untouched, because the tax never went into it.

Watch the bank feed: the state's withdrawal arrives as a line that can get categorized as "taxes" or "sales tax expense". Match it to the payable instead. If your accounting software has a sales tax feature, it may post the tax to a payable for you: record the payment there, or match the bank line to the payable it created.

A payment can bundle other items: use tax, a penalty or interest. Book each to its own account, and keep only the sales tax in the payable. For how often returns and payments are due, see filing sales tax returns.

Why does booking sales tax as an expense overstate my costs?

Because the tax you pass along was never your cost. Publication 334 says not to deduct sales tax imposed on the buyer that you must collect and pay over. An expense entry adds a cost that does not exist, and any payable you built when you collected the tax never clears.

If an income tax return was prepared from those books, it can carry the same errors: a deduction that Publication 334 says not to take, gross receipts that include the tax, or both. Which one depends on how the tax was booked in each year.

How do I record sales tax I pay on purchases?

Sales tax you pay on a purchase is part of what you paid for it, not a separate sales tax expense. Publication 334 says to treat sales tax on a service, or on the purchase or use of property, as part of its cost.

For tax paid on stock, see landed cost in cost of goods sold. For whether to expense or depreciate equipment, see writing off equipment in the first year. If a supplier charged tax on stock you bought to resell, see resale certificates and sales tax refunds.

What if a tax is imposed on me as the seller, like a gross receipts tax?

A tax imposed on you rather than on your customer goes in your gross receipts when you collect it from the buyer. Publication 334 says that if you collect state and local sales taxes imposed on you as the seller, you must include the amount collected in gross receipts. For a sole proprietor on Schedule C, the same publication allows a deduction for a state tax on gross income, as distinguished from net income, that is directly attributable to the business. It speaks only to Schedule C filers; how a partnership or corporation reports the tax is for its preparer.

New Mexico is one example. Its gross receipts tax is imposed on businesses, and a business may pass it on to the buyer; if it does, the amount must be stated separately on the invoice (New Mexico Taxation and Revenue). In the books, the amount collected generally goes into sales, and the tax is a business cost recorded when owed, through a payable until it is paid. Keeping the amount collected out of sales would not follow Publication 334.

States word this differently. California's seller's permit guide says the seller is responsible for paying the tax and may be reimbursed by the customer (CDTFA Publication 73). Publication 334 does not list states, so it does not say which side of its line a given state's tax falls on. That turns on the state's law and your facts. If you collect in a state that words it as the seller's tax, settle the treatment with a preparer before booking it either way.

How do I record use tax when the seller charged none?

Use tax is owed by the buyer when taxable goods or services are used in a state, the seller charged no tax there, and no exemption applies. Add it to the cost of the purchase and to a use tax payable until you report it.

Texas says a purchaser owes use tax on taxable items stored, used or consumed in Texas from a seller that does not charge Texas tax, unless an exemption applies, and its return instructions leave out inventory held exclusively for resale. New York requires a business registered, or required to be registered, for sales tax to report use tax on its sales and use tax return. Other states differ.

When you pay with the return, debit use tax payable and credit cash. Publication 334 treats sales tax on the "purchase or use" of property as part of its cost. It does not name use tax, so confirm with your preparer that use tax gets the same cost treatment, as the entry above assumes. For which purchases owe it and how to report it, see use tax on business purchases.

Where does a timely-filing discount or vendor credit go?

Record it in its own account, apart from sales and from the payable. Some states let a seller keep a small part of the tax collected for filing and paying on time. It reduces the cash you send, so the payable is left with a credit that never clears unless you record the difference in its own account.

Rules differ by state; check your state's return instructions to see whether yours gives one. Texas also gives prepayers a larger discount, which a payable that does not match the return covers. Clear the payable for the full tax due and put the amount you kept in its own account, not in sales. For a Schedule C filer, the IRS instructions say that if the state allows you to retain any part of the sales tax you collected, you must include that amount as income on line 6 (Schedule C instructions). For a partnership or corporation, or for a discount tied to use tax on your own purchases, ask your preparer how it is reported.

What is the sales tax payable balance, and whose money is it?

The balance is the sales tax you have recorded as owed and not yet paid to the state. Where the tax is imposed on the buyer, it is the state's money that you are holding, not yours. New York says a registered vendor is a trustee for the state and must remit tax due, including tax not yet collected on sales in the period. For a corporation or partnership, it adds that certain owners, officers, directors, employees, partners and members, called responsible persons, can be held personally liable for the tax the business owes (Publication 750). Texas says the seller is responsible for collecting and paying the correct amount (Texas Comptroller).

On the balance sheet, the balance is a current liability, not cash free for payroll or the owner. After each return is paid, the balance should hold only tax on sales since the period covered, including tax on unpaid invoices where the state requires a sale to be reported for the period it was made. If it holds more or less, or a customer never paid an invoice you charged tax on, see a payable that does not match the return. For who owes unpaid tax in each state and how far back a state can assess it, see filing sales tax returns.

How do I fix sales tax booked as an expense or income in past years?

Reclassify each period so the tax passes through the payable, then compare the payable to the returns you filed. These steps are for tax imposed on the buyer; a tax imposed on you as the seller stays in sales and stays an expense.

1. List every period. For each, gather the filed sales tax return, the tax due on it, and the payment confirmation.
2. Pull the payable account detail, plus any income or expense account that took sales tax.
3. For each payment booked as an expense, split it first. Only the sales tax collected from customers moves: debit sales tax payable and credit the expense account. Use tax, penalty and interest each go to their own account; a preparer decides how a penalty or interest is reported.
4. For each period where collected tax was booked as sales, debit sales and credit sales tax payable.
5. Compare the payable to the returns. It should equal the tax on sales not yet paid, including tax on unpaid invoices where the state reports a sale when it is made. Differences go to the mismatch guide.
6. Check use tax and any discount or credit separately, as above.

These steps change your books, not what you filed with the state. A correction that touches a year already used for an income tax return raises two questions: whether to restate that year or adjust the current period, and whether the filed return needs amending. The answers depend on what the return reported, and neither is a bookkeeping call.

Example

All figures are in US dollars and are illustrative.

A sale and its payment

A business sells goods for $1,000 and adds 8% sales tax, so the customer pays $1,080. The entry debits cash $1,080, credits sales $1,000 and credits sales tax payable $80. Paying the state $80 debits sales tax payable and credits cash. Sales is $1,000, the profit and loss statement shows no tax, and the payable is back to zero.

Equipment and untaxed supplies

A machine costs $5,000 plus $400 sales tax. It is recorded at $5,400, the base for depreciation. The same business buys $2,000 of supplies online and is charged no tax. At an illustrative 6% use tax rate, it owes $120. It debits supplies $2,120, credits cash $2,000 and credits use tax payable $120, then reports the use tax on its sales tax return.

Two years of payments booked as expense

A business collects 8% on $100,000 of taxable sales each year, so it collects $8,000 a year and pays the state $8,000 in each of those years. It books the tax into the payable, but books each payment to the state as an expense.

• Year 1: expenses are too high by $8,000, profit is too low by $8,000, and the payable shows $8,000 although the state has been paid.
• Year 2: the same again. Expenses are $8,000 too high, and the payable shows $16,000.

The fix debits sales tax payable and credits the expense account by $8,000 in each year, which brings the payable to zero. If the filed returns deducted that expense, the question of whether to amend them follows.

Different for you?

• Payments booked as expenses, or collected tax booked as sales, for a year or more, and an income tax return filed from those books: the profit and loss statement and the return may both be off. A professional can settle which years need correcting and whether the returns change. See bookkeeping help, and cleanup or start fresh for how a cleanup is scoped.
• You collect in a state that words its tax as the seller's, such as New Mexico or California: the entries above may not fit; how the amount collected and the tax are booked turns on the state's law and your facts. See bookkeeping help.
• The payable does not match the return: see a payable that does not match the return.
• A marketplace collected the tax, or you reconcile payouts: see reconciling sales and payouts.
• Card deposits arrive net of fees and tips: see card deposits in the books.
• You run a restaurant or use a POS system: see restaurant sales tax and POS reconciliation.
• You should have collected tax and did not, never sent in tax you collected, or collected tax you were not required to collect: the state may be owed more than the books show. See catching up on uncollected sales tax and bookkeeping help.
• You are unsure whether to keep your own books: see doing your own books or hiring a bookkeeper.