calculating sales tax

What is sales tax?

Sales tax is a tax on the price of a good or service. This tax is a percentage of the price and is added by the final seller.

There are only five states in the United States that do not have a state sales tax. There is little consistency in how states apply sales tax. Some states only collect sales tax on goods and not services. Some states give exemptions for items that are considered necessities, like food and clothing. Some states exempt some services like hair cuts and accounting services. There are a number of accountants who specialize in sales tax regulation because the laws can be so complicated.

Historically, in order for a company to be required to collect sales tax in a state, the company must have nexus in the state. Nexus refers to physical presence in the state. That means the company would need to have buildings or employees in a state in order to have nexus in the state. As the internet and online shopping has grown, states are losing out on billions of dollars in sales tax revenue. According to ,  states lose an estimated $23 billion per year in sales taxes from internet sales. This lead a number of states to pass “Amazon Tax Laws”. These laws redefined the definition of nexus to include companies with affiliates in a state. An affiliate is a blogger, website owner, or anyone who posts affiliate links online. When someone clicks on the link and purchases a product from a website, the affiliate earns revenue. The states argued that these affiliates are akin to sales people and therefore those affiliates create nexus in the state. Congress is also working on bills to force large online retailers to collect sales tax in all states. These laws are constantly evolving and accountants must stay on top of current legislation.

How is sales tax collected?

Sales tax is collected by retailers when goods and services are sold to the final user. Sales taxes are not imposed when materials that will be used to manufacture a product are sold to a manufacturer. When the manufacturer sells their products to a retailer, no taxes are imposed. It is only when the product is sold to the final customer that the taxes are charged. If the sale is not made to the final end user, no sales tax is collect. A few states have made exemptions to this rule, like charging contractors sales tax on materials.

There are two ways that companies can add sales tax to their products. Most companies add sales tax to the price of their products. To calculate the amount of sales tax, multiply the sales tax percentage by the total amount of the sale.

Example #1

A customer purchases $150.00 worth of taxable products from Jeff’s Geek-O-Rama on 2/15. The sales tax rate in the state the store resides is 6%. Calculate the amount of tax and the total amount the customer paid.  

First let’s calculate the tax. The sales tax is 6% of the total purchase, which in this case is $150.00.

$150.00 X .06 = $9

That is the total tax on the transaction. This must be added to the purchase price so the total cash collected is $159.00, but only $150 belongs to Jeff. The other $9 belongs to the state and should be remitted to the state when the next sales tax return is filed.

When recording the transaction, record the cash that was received, the revenue the company earned, and the sales tax that is payable to the state.

ST1

As the month goes on and more sales transactions occur, the sales tax payable account will grow. Most states require monthly payment for sales tax collected. When February’s sales tax is due in March, we will look at how much sales tax was collected and pay that amount.

Example #2

On March 20, Jeff’s Geek-O-Rama pays the sales tax due for February. The store generated $27,250 in taxable sales in February and has a balance in Sales Tax Payable of $1,635 at the end of the month. Record the journal entry to record the payment of the sales tax for February.

This entry is pretty straight forward. It is like recording any other debt payoff. We are paying down the debt. The normal balance in a liability account is a credit balance so in order to pay off that balance we would need to debit the account. How are we paying with sales tax? We are paying it with cash. Cash will decrease which would be our credit. The amount of the entry is $1,635.

ST2

What do we do with sales tax paid on purchases made by the company?

If a business purchases items for the company’s use, like office supplies or equipment, the cost of those items is subject to sales tax. What does a company do with that sales tax?

If you think back to the asset purchase rules, all costs associated with acquiring an asset must be added to the cost of the asset. These costs include sales tax. If a company purchases supplies and pays sales tax, the sales tax is added to the cost of the supplies. If the company purchases a machine and there is sales tax on the purchase, the sales tax is added to the cost of the machine.

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