Sales Tax vs Income Tax: A Guide for Small Business Owners

For small business owners, grasping the intricacies of taxes is very important for financial stability and growth. Among the array of tax types, two frequently entangled concepts are sales tax and income tax. In this blog post, we will share with you the main difference between these two types of tax and also how they may affect your business.

Understanding Sales Tax

Sales tax serves as a consumption “charge” imposed by state and local governments on the purchase of goods and services. It constitutes a percentage of the transaction value and is typically collected by the seller at the point of sale. The tax rate is usually based on the location where the item is sold or ship to, and sometimes it is also based on the type of goods or services being purchased. This is why rates might be different from one sale to another. In addition, some state and local agencies do not impose any sales tax at all, and some agencies will impose sales tax in some items but not in others. Businesses have the responsibility of gathering and remitting sales tax collected to the pertinent tax authorities.

One thing to note is that this tax is paid by the consumer. The seller only collects the tax and remits it to the state and local agencies. If the seller does not collect the appropriate sales tax, in most instances, the seller becomes liable for the sales tax that was not collected. The state and local governments will always go to the seller if there are any discrepancies when it comes to the sales tax they collect.

In most states, sales tax returns are required to be filed on a monthly basis. In the state of Alabama, sales tax returns are due by the 20th of the following month (i.e. sales tax collected in January are due by February 20th). Even if you have $0 in sales in a month, your business is still required to file a monthly sales tax return. Failure to submit your sales tax return will result in a $50 late fee charge.

Understanding Income Tax

Income tax, on the other hand, is a fiscal obligation imposed by federal, state, and local governments on the earnings of individuals and businesses alike. Income tax is based on “taxable income”, which is the total earnings minus allowable deductions and exemptions. Unlike sales tax, income tax is paid directly by individuals and businesses to the government based on their net income, declared annually.

Key Distinctions

Here are some of the key differences between sales tax and income tax:

· Function: Sales tax targets consumption, income tax targets earnings.

· Mechanism used to collect the tax: sales tax is collected by the seller upon each transaction and remitted to state and local agencies; income tax is remitted by each individual and business tax payer directly to the federal, state, and local governments.

· Rates: Sales tax rates are imposed by state and local agencies and they vary by location and by product type; income tax rate is based on the tax brackets created by the IRS or state and local governments.

Implications for Small Businesses

As a small business owner, you may have to pay both sales and income taxes.

But remember – sales tax is NOT an expense to your business. Sales tax is collected from your customers and then remitted to your state and local agencies. As a business, you are just the middleman. Also, you have to keep meticulous records to ensure adherence to tax regulations when it comes to sales tax. As your business grows, you may face the opportunity to make sales in new states, counties, and/or cities. If this is the case, you will have to stay vigilant to make sure you are following sales tax rules so that you are not penalized for non-compliance. This may even involve applying for business licenses in every new location you start selling your goods and/or services. In another blog, we will talk about the concept of “Nexus”.

Income tax may or may not be an expense to your business, and this will depend on the type of entity your business is. For example, if your business is a single member LLC or a sole proprietorship, your income tax is reported in your personal tax return. And the tax payment you make is not an expense to your business; rather, it is a personal draw.

Understanding the difference between sales tax and income tax will help you ensure compliance, and it will also help you make better decisions when it comes to pricing your products and services and also will help you ensure you are setting money aside for these taxes.

There’s a reason why Benjamin Franklin said “Nothing is certain except death and taxes”.