Key takeaways
- Sales tax you collect isn't an expense. It's money you hold for the state, recorded in Sales Tax Payable (a liability). It isn't revenue either.
- Paying it to the state isn't an expense. The payment reduces Sales Tax Payable to zero.
- Sales tax you pay on purchases is part of the cost of what you bought: in the expense, in inventory, or in the asset's basis. There's no separate "sales tax expense."
- Exception: where the tax is legally on the seller (Hawaii, New Mexico, Arizona), the IRS has you include it in gross receipts and deduct it as a tax.
- No sales tax charged on a taxable purchase? You may owe use tax, recorded the same way.
Is sales tax an expense? The short answer
"Sales tax" shows up in two places in a set of books, and they're treated in opposite ways:
- Tax you collect on your sales belongs to the state from the moment you collect it. You're holding it until the return is due. It's a liability, and sending it to the state just pays off that liability.
- Tax you pay when you buy something is part of what the item cost you. It's an expense, but only as part of that item: office supplies with tax are a supplies expense, inventory with tax is inventory, and equipment with tax is equipment.
Here's the first case with numbers. Harbor Coffee Co, a sample coffee shop, sells $100 of coffee beans and charges 8% sales tax:
The IRS treats it the same way for taxes. State and local sales taxes imposed on the buyer that you collect and pay over "are not income," and you don't deduct them either (IRS Publication 334). The rest of this article covers every case, with journal entries and where each amount goes on the tax return.
Which case are you in?
In short: Start with one question: did you collect this tax, or did you pay it?
Did you collect this tax from a customer, or pay it on something you bought?
AYou collected it
- Most states: the tax is on the buyer→ A liability, not revenue or an expenseSales Tax Payable. Leave it out of gross receipts.
- The tax is legally on you, the seller (Hawaii, New Mexico, Arizona)→ Include it in gross receipts, then deduct itSchedule C line 1, then line 23
- The state lets you keep part of it→ The part you keep is incomeSchedule C line 6
BYou paid it
- Supplies or a service→ Part of that expense$200 of supplies + $16 tax = $216 supplies expense
- Inventory you'll resell→ Part of the inventory's costExpensed through cost of goods sold when it sells. A resale certificate avoids the tax.
- Equipment or another asset→ Added to the asset's basisDepreciated (or Section 179 / bonus depreciation)
- The vendor charged no tax→ You may owe use taxTreated the same way as sales tax
The running example below follows Harbor Coffee Co through one month (March) at an 8% rate. The business, the rate, and the amounts are made up to show the entries; your state and local rates will differ.
Sales tax you collect: a liability, not revenue
In short: Collected sales tax goes straight to Sales Tax Payable. It never passes through the profit and loss statement.
“Don't deduct state and local sales taxes imposed on the buyer that you must collect and pay over to the state or local government. Don't include these taxes in gross receipts or sales.”
1. Record the sale
| Account | Debit | Credit |
|---|---|---|
| Cash or accounts receivable | $10,800 | |
| Sales revenue | $10,000 | |
| Sales Tax Payable | $800 |
$10,000 × 8% = $800. Revenue is $10,000, not $10,800.
2. Record a return
| Account | Debit | Credit |
|---|---|---|
| Sales returns and allowances | $500 | |
| Sales Tax Payable | $40 | |
| Cash | $540 |
The refund includes the $40 of tax, so the liability drops to $760.
3. Pay the state
| Account | Debit | Credit |
|---|---|---|
| Sales Tax Payable | $760 | |
| Cash | $760 |
No expense account. The payment only clears the liability.
Sales Tax Payable: Harbor Coffee Co, March
Debit (decrease)
Credit (increase)
If your state lets you keep part of the tax
Some states give a small discount for filing and paying on time. Texas, for example, allows a 0.5% timely filing discount (Texas Comptroller). The IRS says any part of collected sales tax you're allowed to keep is income, reported on Schedule C line 6.
| Account | Debit | Credit |
|---|---|---|
| Sales Tax Payable | $760.00 | |
| Cash | $756.20 | |
| Other income: sales tax discount | $3.80 |
$760 × 0.5% = $3.80. Rules and rates vary by state, and some states have capped or ended their discounts.
Sales through a marketplace
When a marketplace such as Amazon or Etsy collects the tax and sends it to the state, the tax isn't your liability. Don't create Sales Tax Payable for those orders. If the payout report shows the tax, record it in and out, or leave it out of both sides, so it nets to zero.
Bookkeeper tip: At each month end, tie the Sales Tax Payable balance to the return you're about to file. Tax charged, minus tax refunded, minus payments, should equal what the return says you owe. When it doesn't, look first for a payment coded to an expense or a bank deposit that was never split between sales and tax.
Sales tax you pay on purchases: part of the cost
In short: Add the tax to whatever you bought. Where it ends up depends on what the item is.
“Treat any sales tax you pay on a service or on the purchase or use of property as part of the cost of the service or property.”
The same passage then gives the three cases: if the item is a deductible business expense, deduct the tax as part of it; if it's merchandise bought for resale, the tax is part of the cost of the merchandise; if it's depreciable, add the tax to the basis for depreciation. The Schedule C instructions repeat it: don't deduct sales tax on property bought for the business as a tax, "instead, treat these taxes as part of the cost of the property."
| What you bought | Where the tax goes | Harbor Coffee Co example |
|---|---|---|
| Supplies or a service | In the same expense account | $200 of cups and lids + $16 tax = $216 supplies expense |
| Inventory to resell | In inventory, then cost of goods sold when it sells | $1,000 of bagged coffee + $80 tax = $1,080 inventory |
| Equipment or other asset | In the asset's cost (basis), then depreciated | $2,400 espresso machine + $192 tax = $2,592 equipment |
Journal entries
| Account | Debit | Credit |
|---|---|---|
| Supplies expense | $216 | |
| Cash | $216 |
| Account | Debit | Credit |
|---|---|---|
| Equipment | $2,592 | |
| Cash | $2,592 |
Depreciation, Section 179, or bonus depreciation is figured on $2,592 (IRS Topic 703: cost "includes sales tax").
Inventory: use a resale certificate
Merchandise you buy to resell is normally bought tax-free: you give the vendor a resale (exemption) certificate, and the tax is charged later to your customer. If a vendor charges you tax on inventory anyway, the tax becomes part of the inventory's cost and reaches the profit and loss statement only through cost of goods sold. Ask the vendor for a credit instead; it's usually money you shouldn't have paid.
The $2,500 de minimis trap
Under the de minimis safe harbor, a business without audited financial statements can choose to deduct tangible property that costs up to $2,500 per item or invoice instead of depreciating it (IRS Publication 334). The regulations say to include other costs on the same invoice, "for example, delivery fees, installation services, or similar costs." The IRS doesn't name sales tax there, but the tax is part of the item's cost.
| Price on the invoice | $2,400 |
| Sales tax on the same invoice (8%) | $192 |
| Cost to test against the limit | $2,592 |
Tested with the tax, it's over $2,500, so it goes on the books as equipment. That's our careful reading, not an IRS example: ask the tax preparer about items close to the limit.
Bookkeeper tip: Don't open a "Sales Tax Paid" or "Sales Tax Expense" account for purchases. It pulls tax out of inventory and equipment, where the IRS says it belongs, and it looks like a tax deduction the business can't take in that form.
When the vendor doesn't charge tax: use tax
In short: If you buy something taxable for the business and the seller charges no sales tax, you may owe use tax to your own state.
Use tax is the buyer's side of sales tax. It typically comes up with out-of-state or online sellers that don't collect tax in your state, and when you use something you bought tax-free with a resale certificate yourself instead of reselling it. It's usually reported on the business's sales and use tax return; your state's revenue department explains how.
In the books, use tax works like sales tax you paid: it's part of the item's cost. The IRS wording covers it ("the purchase or use of property").
| Account | Debit | Credit |
|---|---|---|
| Supplies expense | $540 | |
| Cash | $500 | |
| Use Tax Payable | $40 |
When the return is filed: debit Use Tax Payable $40, credit cash $40. For inventory or equipment, debit that account instead of supplies.
When the tax is on the seller: Hawaii, New Mexico, Arizona, and Washington
In short: In a few states the tax is legally owed by the business, even when it's passed on to customers. Then it's the business's own tax expense.
Most articles say collected sales tax is "never" deductible. That's true only when the tax is imposed on the buyer. The Schedule C instructions let you deduct "state and local sales taxes imposed on you as the seller of goods or services," and add: "If you collected this tax from the buyer, you must also include the amount collected in gross receipts or sales on line 1." Profit comes out the same, but gross receipts are higher.
| State | Tax | What the state says |
|---|---|---|
| Hawaii | General excise tax (GET) | "not a sales tax imposed when title passes. Rather, the general excise tax is a gross receipts tax" (Hawaii Administrative Rules §18-237-13-02.01) |
| New Mexico | Gross receipts tax (GRT) | "imposed on businesses, but it is common for a business to pass the GRT on to the purchaser" (New Mexico Taxation and Revenue Department) |
| Arizona | Transaction privilege tax (TPT) | "a tax on the vendor for the privilege of doing business in the state" (Arizona Department of Revenue) |
| Washington | Business and occupation (B&O) tax | "a tax on the seller and is a part of the seller's overhead"; Washington's retail sales tax, by contrast, is collected from the buyer (Washington Department of Revenue) |
In these cases, record the tax you charge as part of sales and the tax you owe as a tax expense (Taxes and licenses). Washington businesses have both: B&O tax is an expense, and retail sales tax is a normal liability.
For GAAP financial statements: ASC 606-10-32-2A lets a business elect to leave sales, use, and similar taxes collected from customers out of revenue, but "taxes assessed on an entity's total gross receipts" are outside that election. If a client issues GAAP statements in one of these states, confirm the presentation with their CPA.
Other states word their rules in their own ways. If you're not sure who a tax is legally imposed on, check the state revenue department's guidance before choosing a treatment.
Where sales tax goes on Schedule C
In short: For a sole proprietor or single-member LLC, each kind of sales tax lands in a different place, or nowhere.
| Amount | Schedule C | Harbor Coffee Co, March |
|---|---|---|
| Sales, without collected tax imposed on the buyer | Line 1, gross receipts | $10,000 |
| Returns | Line 2 | $500 |
| Collected tax (on the buyer) and the payment to the state | Nowhere | $760 |
| Discount the state let you keep | Line 6, other income | $3.80, if filed with the discount |
| Tax on supplies | With the supplies, line 22 | $216 total |
| Tax on inventory | Cost of goods sold, Part III | In the $1,080 cost, if charged |
| Tax on equipment | In depreciation or Section 179 (line 13, Form 4562), or Part V if under the de minimis limit | In the $2,592 basis |
| Tax imposed on you as the seller | Line 1 (amount collected) and line 23 | Not in this example |
| Late-filing penalties | Not deductible |
Penalties and fines paid to a government agency because you broke the law aren't deductible (IRS Publication 334). Keep late-filing penalties in their own account so they don't slip into taxes and licenses.
Not the same topic: the sales tax deduction on Schedule A is a personal itemized deduction for sales tax on personal purchases. Business purchases don't go there; their tax is already in the business costs above.
Common mistakes with sales tax in the books
In short: The most common one is booking the payment to the state as an expense.
It happens when the bank feed shows a payment to the state department of revenue and it gets categorized like any other bill. Here's what it does to Harbor Coffee Co's March numbers:
✕ Payment coded as an expense
Profit is $760 too low, and Sales Tax Payable still shows $760 that was already paid.
✓ Payment applied to Sales Tax Payable
The liability goes to $0 and profit is right.
| Mistake | Why it's a problem | What to do instead |
|---|---|---|
| Payment to the state coded as an expense | Profit too low; the liability stays open | Apply the payment to Sales Tax Payable (in your software's sales tax payment screen) |
| Deposits recorded as sales, tax included | Revenue too high; tax never recorded as owed | Split each deposit between sales and Sales Tax Payable |
| A separate "sales tax expense" for purchases | Inventory and equipment costs are understated | Add the tax to the item's cost |
| De minimis tested on the price before tax | Items just over $2,500 get expensed | Test the invoice total including tax |
| Marketplace sales booked with tax payable | A liability that the marketplace already paid | Leave the marketplace's tax out of Sales Tax Payable |
| Ignoring use tax | Tax owed to the state goes unreported | Accrue it when a taxable purchase has no tax |
| Treating Hawaii GET or Arizona TPT like a buyer's sales tax | Gross receipts don't match the IRS rule | Include it in sales and deduct it as a tax |
Explaining it to a client
Clients often see the payment to the state and ask why it isn't on their profit and loss. A short note with their numbers works better than a lecture:
Sample wording for a client
Quick note on your sales tax: the $760 you paid the state for March isn't an expense on your profit and loss, because it was never your money. It was added to your customers' receipts, held in a liability account, and passed on to the state. Sales tax you pay when you buy supplies or equipment is different: it's included in what those items cost you.
Frequently asked questions
Is sales tax an expense or a liability?
It depends on which side of the sale you're on. Sales tax you collect from customers is a liability: you hold it for the state until you file, so it goes to Sales Tax Payable, not to revenue or expenses. Sales tax you pay when you buy something for the business is part of that item's cost, so it ends up in the matching expense, in inventory, or in the asset's value.
Should I record my sales tax payment to the state as an expense?
No, not for tax you collected from customers. The payment reduces Sales Tax Payable: debit Sales Tax Payable, credit cash. Coding it as an expense makes profit too low and leaves the liability showing money you've already paid. The exception is a tax your state imposes on the seller, such as Hawaii's general excise tax, which is included in gross receipts and deducted as a tax.
Is sales tax collected considered income?
Not when the tax is imposed on the buyer, which is the usual case. IRS Publication 334 says state and local sales taxes imposed on the buyer that you were required to collect and pay over are not income. If your state lets you keep a small part of the tax as a timely-filing discount, the part you keep is income and goes on Schedule C line 6.
Do I include sales tax in gross receipts on Schedule C?
Leave it out when the tax is imposed on the buyer; it's neither gross receipts nor a deductible expense. When the tax is imposed on you as the seller and you collected it from the buyer, include it in gross receipts on line 1 and deduct the tax on line 23 (Instructions for Schedule C).
Is sales tax deductible for a business?
Sales tax you pay on business purchases is deductible, but as part of the cost of what you bought, not as a separate tax. The IRS says to treat it as part of the cost of the service or property: deduct it with the expense, include it in the cost of merchandise you resell, or add it to the basis of depreciable property. Sales tax you collected from customers isn't deductible because it was never your income.
Is sales tax on inventory part of cost of goods sold?
Yes. If you pay sales tax on merchandise you buy to resell, the tax is part of the cost of the merchandise, and it becomes cost of goods sold when the goods sell. Most sellers avoid paying it in the first place by giving the vendor a resale certificate.
Do I add sales tax to the cost of equipment?
Yes. If the property is depreciable, the IRS says to add the sales tax to the basis for depreciation. A $2,400 espresso machine with $192 of sales tax goes on the books at $2,592, and depreciation, Section 179, or bonus depreciation is figured on $2,592.
Does sales tax count toward the $2,500 de minimis limit?
The IRS doesn't say so in those words. But the tax is part of the item's cost, and the de minimis rule requires you to include other costs on the same invoice, such as delivery and installation. The careful approach is to test the total including tax: a $2,400 item with $192 of tax is $2,592, which is over $2,500. Ask the tax preparer if an item is close to the limit.
What is use tax, and do I owe it on online purchases?
Use tax is the buyer's side of sales tax. If you buy something taxable for the business and the seller doesn't charge sales tax, for example an out-of-state online seller, you generally owe use tax to your state at your local rate. It's usually reported on your sales and use tax return. For your books it works like sales tax you paid: it's part of the cost of the item.
What is the journal entry for sales tax collected and paid to the state?
When you make a $10,000 taxable sale at 8%: debit cash or accounts receivable $10,800, credit sales $10,000, credit Sales Tax Payable $800. When you file and pay: debit Sales Tax Payable, credit cash, for the amount on the return. No expense account is used.
Are sales tax penalties deductible?
No. IRS Publication 334 lists penalties and fines paid to a government agency because you broke the law among the expenses you can't deduct. Record late-filing penalties in their own account, not in Sales Tax Payable or in a general tax expense account, so they're easy to leave out at tax time.
Sources
- Publication 334 (2025), Tax Guide for Small Business, Internal Revenue Service
- Instructions for Schedule C (Form 1040) (2025), Internal Revenue Service
- Topic no. 703, Basis of assets, Internal Revenue Service
- Guide to business expense resources (Publication 535 discontinued after 2022), Internal Revenue Service
- 26 CFR 1.263(a)-1(f), de minimis safe harbor, Electronic Code of Federal Regulations
- Hawaii Administrative Rules §18-237-13-02.01, Justia Regulations
- Gross receipts overview, New Mexico Taxation and Revenue Department
- Transaction privilege tax (TPT) forms, Arizona Department of Revenue
- Business and occupation tax, Washington Department of Revenue
- Sales and use tax FAQs: reporting and paying, Texas Comptroller of Public Accounts
- ASC 606-10-32-2A, sales taxes and similar taxes (Revenue Recognition Roadmap, 6.7), Deloitte DART
Rules were checked at the IRS and state revenue departments in September 2026. State sales tax rules, rates, and discounts change often. This article covers US federal rules and general bookkeeping practice; it's general information, not tax advice. Confirm the treatment for a specific client with their tax preparer.