Presenting Sales Tax on the Business Return
Incorrect treatment could cause lost tax benefits and examination issues
Many businesses must remit sales tax to a state or locality because they sell property or services. The treatment of those amounts for federal tax purposes depends on whom the state or locality imposes the sales tax.
§448 provides a gross receipts definition often referenced by other Code provisions. Treas. Reg. §1.448-1T(f)(2)(iv)(A), which also applies to tax years beginning after December 31, 2017, states that
…gross receipts do not include amounts received by the taxpayer with respect to sales tax or other similar state and local taxes if, under the applicable state or local law, the tax is legally imposed on the purchaser of the good or service, and the taxpayer merely collects and remits the tax to the taxing authority. If, in contrast, the tax is imposed on the taxpayer under the applicable law, then gross receipts shall include the amounts received that are allocable to the payment of such tax.
Tax Imposed on the Consumer
If the tax is imposed on the consumer, the business is simply collecting the tax and remitting it to the state or locality on behalf of the consumer. The amounts collected are not gross receipts for the business nor an expense when remitted.
When the business collects sales tax from the consumer, it should debit cash and credit sales tax payable. When the business remits the sales tax to the government, the business should credit cash and debit sales tax payable.
The business cannot claim a deduction for taxes paid when imposed on the consumer because Treas. Reg. §1.164-1(a) generally only permits a deduction for taxes paid by the person upon whom they are imposed.
Tax Imposed on the Business
If the tax is imposed on the business, it may or may not pass that cost on to the consumer; it is not required. If the business passes the cost to the consumer, either as a separately stated charge or as part of the overall cost, the amounts received that are allocable to the payment of the sales tax are included in gross receipts.
Since the sales tax is imposed on the business, Treas. Reg. §1.164-1(a) permits a deduction for the sales tax paid to the state or locality.
When the business collects sales tax-related amounts from the consumer, it should debit cash and credit gross receipts. When it remits the sales tax to the state or locality, it should credit cash and debit sales tax expense.
Why This Matters
Properly presenting sales tax issues on the tax return is important for four reasons. The first is technical accuracy. Every tax professional should strive to prepare an accurate return; in this case, the proper treatment is evident in almost all cases.
Second, the improper inflation of gross receipts can lead to the loss of other federal tax benefits. Most provisions tied to gross receipts use a three-year average, and the thresholds are usually inflation-adjusted. Here are some examples:
COVID-19 employee retention credit recovery startup business ($1 million)
Treas. Reg. §1.263(a)-3(f) small taxpayer safe harbor election ($10 million)
Simplified inventory rules ($30 million for tax year 2024)
Expanded use of the cash method of accounting ($30 million for tax year 2024)
Avoiding the uniform capitalization (UNICAP) rules ($30 million for tax year 2024)
Avoiding the §163(j) business interest limitation ($30 million for tax year 2024)
Third, a discontinuity between income tax return gross receipts and sales tax return gross receipts can trigger additional scrutiny if any of the returns are examined. In Publication 5495 (3-2021), Retail Audit Technique Guide, the IRS notes the following on pp. 33-34:
The gross sales reported to a state sales tax agency will generally match the gross receipts reported on the income tax return. If not, reconcile any differences. It is also important to determine whether sales taxes were included in the total sales dollars. The retailer should not include sales taxes in gross receipts and should not deduct state and local sales taxes collected and paid over to the state or local government. Be alert for double deductions in sales taxes paid for purchased items, such as taxes included in cost of goods sold and as a separate expense item.
Last, the improper presentation of sales tax collected on the taxpayer’s books and tax returns can misrepresent actual business performance by inflating gross receipts. A potential buyer could be misled to offer more than the business is worth, or a financial institution could be misled to provide a loan or other product it otherwise would not offer.