As a firm that works exclusively with UK companies doing business in the US, we frequently encounter confusion among our clients regarding the proper accounting treatment of US sales taxes – both when collected and when remitted.
Accounting for US sales tax differs significantly from UK VAT due to a fundamental distinction between the two systems. In the US, sales tax applies only to sales made to the end consumer, whereas in the UK, VAT is applied at every stage of the supply chain. Consequently:
- US sales tax is not reclaimable, meaning businesses cannot deduct the sales tax they pay on purchases from their tax liability.
- Sales tax paid on purchases is treated as part of the total cost of goods or services rather than as a separate asset.
As a result, accounting entries for these transactions differ significantly. Specifically:
- Sales tax paid on company purchases. Because sales tax paid on company purchases is not reclaimable, the tax is not posted to an asset account. In fact, posting the tax paid to any separate account would serve no useful purpose. What the company really needs to know is the total cost of the goods and services consumed (inclusive of taxes). As a result, sales tax paid is posted to the same account as the product or service purchased.
- Sales tax collected from customers. With respect to sales tax, a US company is merely a collection agent for the government. The tax collected belongs to the government, not the company. As a result, sales tax collected is not revenue. Instead, it is posted simply to a sales tax liability account. When the tax is remitted, the sales tax liability is discharged by crediting cash and debiting the sales tax liability account.
Two other observations are in order.
First, to reward the company for its collection efforts, various state governments sometimes pay the company a small vendor allowance. Florida, for example, offers a credit equal to 2.5% of the tax collected, up to $30. Thus, if the company remits tax of $1000, the proper entries would be:
Debit Sales Tax Liability $1000
Credit Cash $975
Credit Other Income $25
Second, the surest way to get in trouble in the sales tax world is to collect sales tax and not remit it. The government rightfully views this as stealing their money. Without software (like A2X) that integrates your sales platform with your accounting system, you may need to regularly enter manual journal entries to account for sales tax collected. Because sales tax is sometimes remitted quarterly or even monthly, you should always know at any given time exactly how much sales tax you owe.