To calculate sales tax, use the steps outlined below to set up the correct sales tax for a new customer. For an existing customer, you only need to use the final three steps for the sales tax calculation. These steps are needed to ensure that a business does not over-charge or under-charge a customer for taxes.
- Determine whether you have nexus for a customer. Nexus is when you have a place of business within the boundaries of a government jurisdiction, or use your own vehicles to transport goods there, or send your employees into that area on business.
- If there is nexus, set up the appropriate sales tax percentage in the database record of the customer for which you want to record a sale. This may include the compilation of separate sales tax percentages for the applicable state, county, city, and special taxation district. For example, if the state tax is 4%, the county tax is 1% and the city tax is 2%, then the grand total tax charged to the customer will be 7%; the customer does not see this breakdown of individual taxes by government jurisdiction.
- If a customer is exempt from sales taxes, make sure that it has sent a valid sales tax exemption certificate. Then create a flag in the database record of the customer that no sales tax is to be charged to it.
- Create an invoice to document the sale to the customer. The software should automatically pull the applicable tax rates from the database record for the customer and apply it to the total of all items listed in the invoice.
- If some customer purchases are exempt from sales taxes, flag these items on the invoice, and verify that the calculated sales tax does not include it.
- Record the sales tax liability in the accounting records. If you sent an invoice to the customer for later payment, the entry is a debit to the accounts receivable account and a credit to the liability account for sales taxes payable. If the customer paid in cash at the point of sale, the entry is a debit to the cash account and a credit to the liability account for sales taxes payable.
In order to receive updates on the correct sales tax percentages, file to do business with the various governments in whose jurisdictions the company has nexus. It may be sufficient to file to do business at the level of the applicable state government.
If you are remitting sales taxes to multiple government authorities (as will be the case when there is nexus in multiple states), establish a different sales tax liability account for each government jurisdiction to which you are remitting sales taxes. Otherwise, it will be very difficult to calculate payments to each jurisdiction.
This concludes the calculation of sales taxes. If you want to also record the eventual remittance of sales taxes to the applicable government authorities, record a debit to the liability account for sales taxes payable and credit the cash account.