Is Sales Tax an Expense or a Liability?

Sales tax is a consumption tax on goods and services, paid by the consumer. Businesses collect this tax at the point of sale and remit it to government authorities. This article clarifies how sales tax is treated in a company’s financial records, addressing whether it is an expense or a liability.

Understanding Expenses and Liabilities

In accounting, an expense represents a cost incurred by a business to generate revenue. These costs are typically consumed within a single accounting period and reduce a company’s net income. Common examples of business expenses include employee wages, rent for office space, utility bills, and advertising costs. Expenses are recorded on the income statement, directly impacting the profitability reported by a business.

A liability, in contrast, is a financial obligation or debt that a business owes to an external party. Liabilities represent future economic sacrifices that an entity is required to make due to past transactions. Examples of liabilities include accounts payable (money owed to suppliers), loans, and unearned revenue (money received for services not yet rendered). Liabilities are reported on the balance sheet, reflecting claims against a company’s assets.

The Business Role in Sales Tax

Businesses act as intermediaries in the sales tax collection process, gathering funds on behalf of state or local governments. When a customer purchases a taxable good or service, the sales tax is added to the item’s price. The business collects this total amount from the customer, but the sales tax portion does not belong to the business itself.

These collected sales tax funds are held in trust by the business for the taxing authority. The money is not considered revenue for the business, as it will be transferred to the government. Businesses must accurately collect, safeguard, and timely remit these funds.

Accounting for Sales Tax

Sales tax collected from customers is recorded as a liability on a company’s balance sheet. It is categorized as “Sales Tax Payable” within current liabilities, representing a short-term obligation due within one year. This reflects that the business owes these funds to the government, not that it has incurred an expense.

When a sale occurs, the total amount received from the customer, including sales tax, is recorded. For example, if a $100 item with a 5% sales tax is sold, the business collects $105. In the accounting records, the Cash or Accounts Receivable account is debited for $105. Sales Revenue is credited for $100, representing the actual income from the sale, and Sales Tax Payable is credited for $5, acknowledging the obligation to the government. The sales tax never enters the business’s revenue or expense accounts.

When the time comes to remit the collected sales tax to the government, the Sales Tax Payable account is debited, which reduces the liability. Simultaneously, the Cash account is credited for the same amount, reflecting the outflow of funds to the taxing authority. This two-step process clearly shows that the sales tax is a pass-through amount, collected and then remitted, without affecting the business’s operating expenses or profits.

Practical Considerations for Businesses

Classifying sales tax as a liability has practical implications for businesses. Since it is not revenue, sales tax does not directly impact a business’s reported net income or profitability. It represents a transfer of funds collected from customers, not an operating cost.

Accurate collection, tracking, and timely remittance of sales tax are important for businesses. Non-compliance can result in significant penalties, including flat fees for late submissions, percentage-based fines on unpaid tax, and escalating charges for repeated offenses. Many states impose penalties ranging from 5% to 10% of the unpaid amount monthly, often with additional interest. Willful failure to remit collected sales tax can lead to severe fines or legal action, as it is considered a “trust fund” belonging to the government.