As a tax professional serving retailers, I often hear the phrase “but I can’t pay the sales tax.” These retailers fall into the trap of thinking that the sales tax they collect on their product or service belongs to them. Unfortunately, that is not the case and failure to pay the full amount of taxes collected from consumers will be considered a criminal act. The business owner, who does not pay the full amount of taxes collected, is essentially stealing funds from the state or local government by imposing the sales tax requirement.
In other words, the business owner is helping the government raise its funds. Therefore, to make the process easier for the business owner and to avoid any audit issues with the state or local government, the sales tax collected should be treated as a cost of sales and removed from sales revenue. sales and reserve For example:
Company A has sales revenue of $1,100. Company A does business in Illinois and is required to apply a 10% tax on each sale. Of that $1,100, $100 is the sales tax collected. As a result, Company A’s actual sales revenue is $1000, which can be used for the business. The $100 must be set aside to send to the state or local government.
Let’s break down this tricky topic and try to alleviate some of the confusion…
What is sales tax?
This is a tax imposed by a state and/or local government that is paid by the buyer for goods and sometimes services. As a business owner, you may need to assess this tax on your products or services, collect it, and then remit it to the appropriate state or local government within a prescribed time frame determined by the competent authority.
Sales tax laws and rates will vary from state to state. This will often add to this tax dilemma, especially if you are selling to customers in more than one state. On the other hand, there are some states that do not impose a general sales tax, but may have in-state locations that do.
The state or locality that imposes this tax requirement will inform the business when to pay the taxes collected, either monthly or quarterly. Each state will have a special tax return to report ALL sales, taxable sales, exempt sales, and the amount of tax due. It would be a mistake to think that you would only report taxable sales. ALL sales must be reported because when you file your annual tax returns, it will include ALL income. If the state or locality compares the total revenue on the annual income tax return with the sales tax returns and finds a difference, that can trigger a state audit. To avoid red flags, it is best to report ALL sales and use the appropriate sections on the sales tax return to show what are taxable and nontaxable sales.
In order for a business to collect sales tax, it may need to obtain a sales tax permit. It is best to seek the advice of a tax professional when setting up your business to ensure that you have all the information you need to successfully operate your business without overlooking or ignoring business tax obligations.
Who determines the sales tax rate?
The tax rate is determined by the state or local government where the business plans to operate. When the business goes through the registration process with the state or locality, the business owner will be informed of the tax rate. Sometimes the business may have multiple tax rates depending on the products being sold.
Are there commercial transactions that are exempt from sales tax?
The goods or services to which this tax applies will vary from state to state, but generally a business will not be required to collect sales tax on resale items, raw materials, and non-profit organizations.
Resale items are basically items purchased in bulk to be resold. Sales tax is generally not paid on these items because the consumer is expected to pay the tax on the items when they purchase them from the retailer. Raw materials are materials that a company uses to produce and sell a product. If your company sells these raw materials, you will normally not have to collect this tax. Lastly, sales to non-profit organizations are exempt from this tax.
Most importantly, if a business is involved in any of the above transactions, it is important to have or request a copy of the buyer’s tax-exempt or reseller certificate. You will always need documentation to show why sales tax collection was not required.
What if you sell to consumers in different states?
This is where the “sales tax nexus” comes into play. Nexus, also known as “sufficient physical presence,” is a legal term that refers to the requirement that companies doing business in a state collect and pay sales tax in that state. This is a complicated gray area of this tax law and is common for e-commerce and online business owners; however, other companies can also fall for this. This creates additional confusion because the business owner wonders what state rules to follow and whether or not to collect sales tax.
Nexus occurs when a business has a connection to a state, either through physical or economic presence. Physical presence can include having an office, employee, warehouse, subsidiary, or inventory warehouse in a state. Economic presence can create a nexus in a state when a seller achieves a certain amount of sales, either through dollar amount or number of sales transactions, to customers located in that state.
The topic of sales tax can be very overwhelming, as business owners would rather focus on growing their business and increasing their profits, without wondering what taxes are due and paid. To help alleviate some of the stress that comes with handling business tax requirements, seek the advice and assistance of a qualified tax professional.
It is of utmost importance to subtract the amount of sales tax collected from a consumer from daily sales and set aside. This is critical because it would be a huge disappointment for a business owner, who includes the tax collected in his total income, to realize that he didn’t make as much money as initially perceived. Getting in the habit of separating the taxes collected from total sales will help the business owner realize his actual sales and avoid spending money that doesn’t belong to the business in the first place.
