Since we just finished up our series on Sales and Use Tax Audits, I thought we might as well hit one more item that relates to sales tax: the effect of cash versus accrual accounting methods on your sales tax filings.
Just as a refresher, when your accounting is done on an accrual basis, revenue is recognized when the billing goes out to the client. On a cash basis, revenue is recognized when the client actually pays the bill, and you have deposited the funds. The same is true on the payables end. In an accrual system, expenses are recognized when your vendors bill you. In a cash system, the expenses are recognized on the books until you actually pay those bills.
So, how does that affect your sales tax filings? When you file your sales tax return, you must report the amount of sales during the filing period. You then must breakout the portion of those sales, which were taxable sales, and the amount of tax collected on those sales. If you’re doing your accounting on an accrual basis, your sales tax payable will be based on the billings you’ve sent out, regardless of whether you’ve collected payment from those clients or not. On a cash base system, you will only be required to pay into the state the actual sales tax collected from clients, not what you may have billed.
For example: Company A operates on the accrual system. They have billed out $100,000.00 worth of taxable sales in the filing period. They have collected only $65,000.00 worth of those billings at the end of the filing period. If their sales tax rate is 5%, they will need to pay in 5% of the total billings of $100,000.00 for the tax period, $5,000.00.
Company B operates on a cash system. They have billed out the same $100,000.00 worth of taxable sales and collected the same $65,000.00 at the end of the filing period. Since they are on a cash system, they only need to pay in 5% of the $65,000.00 received, or $3,250.00.
Company A, on the accrual system, is having to provide the government with $1,750.00 of funds that they have not received into their bank account yet.
As you can see, it can make quite a difference on your cash flow, depending on how you report your sales tax. So which accounting method should you use when filing your sales tax? You are required to file your sales tax using the same accounting method you use for filing your income tax. If you file your income tax on a cash basis, then you should also file your sales tax on a cash basis. You cannot not mix and match, filing sales tax under one method and income tax under the other method. Just maintain consistency with your accounting and filing methods, that’s the key.