Do you include sales tax in business expenses?

Should Sales Tax Be Included in Business Expenses? The IRS Answer

This is a two-part answer:

1. Sales tax collected from customers is a liability, not an expense. It is money held for the state and is not deductible.
2. Sales tax paid on business purchases is generally deductible, because it is usually included in the cost of the underlying expense or asset.

Both answers are correct; they apply to different types of sales tax, and separating those two concepts is the key.

Two Types of Sales Tax: Collected vs. Paid

Sales tax collected from customers

When your business charges customers sales tax, that money is generally recorded as a liability, often in a Sales Tax Payable account, until remitted to the state.

It is:

• Not revenue
• Not a business expense
• Not deductible

It was never the business’s money to spend, so it does not create an expense deduction.

Sales tax paid on business purchases

Sales tax your business pays when buying goods or services is different. That tax generally becomes part of the cost of what you purchased and is usually deductible through that expense.

In short:

• Collected sales tax = liability
• Paid sales tax = part of business cost
  

Sales Tax on Operating Expenses: How to Record It

For ordinary operating expenses, sales tax is generally included in the total cost of the expense.

Example:
If office supplies cost $100 plus $8 sales tax, record $108 as the office supplies expense.

The full amount (purchase price plus tax)is generally the deductible expense.

In most cases, you would not create a separate “Sales Tax Paid” expense line for this. The tax is absorbed into the related expense category.

Sales Tax on Inventory: How It Flows Through COGS

When sales tax is paid on inventory purchases, it generally becomes part of the inventory’s cost basis.

That means it is included in inventory costs and later flows into Cost of Goods Sold (COGS) when the inventory is sold.

This ensures the full cost, including sales tax, is captured through the COGS deduction.

Sales Tax on Capital Assets: It Must Be Capitalized

Sales tax paid on capital assets—such as equipment, machinery, or furniture—generally must be included in the asset’s cost basis, not deducted separately as an expense.

Example:

• Equipment purchase: $50,000
• Sales tax: $4,000
• Depreciable basis: $54,000

That full basis is then recovered through depreciation (or potentially expensing provisions where applicable).

Expensing the tax separately instead of capitalizing it can create tax compliance issues.

Common Mistakes That Trigger IRS Problems

Common errors include:

1. Claiming a separate sales tax deduction on top of an already expensed cost
   That can create a double deduction.
2. Expensing sales tax on capital assets instead of capitalizing it
   Asset-related tax generally belongs in basis.
3. Confusing personal SALT deduction rules with business treatment
   The personal Schedule A SALT cap is a separate issue and does not generally limit properly deductible business expenses.
4. Recording collected sales tax as revenue
   It should usually be recorded as a liability, not income.

These are common bookkeeping mistakes with tax consequences.

State Sales Tax Rules and Resale Exemptions

Five states have no statewide sales tax:

• Oregon
• Montana
• Delaware
• New Hampshire
• Alaska (though some local sales taxes may apply)

If you purchase goods for resale, a resale certificate may allow you to avoid paying sales tax in the first place.

Best practices include:

• Maintaining resale exemption certificates
• Verifying exemption status periodically
• Keeping exemption documentation with vendor records
  

How to Set Up Sales Tax Accounts in Your Accounting Software

A common setup is:

Sales Tax Payable (Liability Account)
Use this for tax collected from customers and owed to the state.

Expense and Asset Accounts
Sales tax you pay should generally be absorbed into:

• Expense accounts (office supplies, utilities, etc.)
• Inventory
• Fixed assets

In most cases, avoid creating a standalone “Sales Tax Paid” expense account, since that often leads to misclassification or double counting.

How Slash Helps Businesses Track and Report Sales Tax Accurately

Slash is a business banking platform that can capture the full amount of any transaction (including embedded sales tax) and route it to the correct expense or asset account. Any purchases above a preset capitalization threshold can be flagged for finance team review before being coded.