GAAP Accounting Rules for Sales Tax on Discounts
Generally accepted accounting principles, or GAAP, set standards for consistency in recording and reporting financial information. Because external audit and tax reports follow GAAP standards, your business most likely already complies with GAAP accounting rules for collecting and reporting sales tax on discounts.
Sales tax -- and the sales tax rate -- is a percentage of the purchase price of certain retail goods as well as certain services that buyers must pay at the time of purchase. As of 2013, 45 states and the District of Columbia have sales tax laws pertaining to tangible personal property items and certain services. Cities in another 37 states also collect local sales tax, making sales tax in some areas substantial. GAAP rules apply because sales tax is a “pass-through” tax, meaning a business acts as an intermediary, collecting the tax on behalf of the taxing authority and remitting sales tax on behalf of its customers.
Sales discounts are often used to get customers in the door, as incentive to encourage customers to purchase in bulk or as an incentive to pay credit invoices early. Regardless of how the business uses sales discounts, the amount of the discount isn’t taxable. Instant savings and quantity discounts -- also called trade discounts -- can be dealt with at the checkout register. Accounts receivable will need to adjust credit invoices and the sales tax that applies at the time the customer remits payment.
The generally accepted method for handling trade discounts is to discount the item at the register. Trade discounts are most often ignored for accounting purposes in that they are absent from accounting records altogether. Instead, the discount price is recorded as the net sale. Sales tax is calculated and collected on the amount of the net discount sale price. For example, if an item regularly priced at $100 is discounted to $90, sales tax will be collected on the net sale of $90 rather than the normal selling price.
The generally accepted method for handling cash discounts on a credit sale is to record and track the discount in a separate sales discount account. Because you have no way of knowing whether the customer will take advantage of the cash discount at the time of the sale, debit accounts receivable for the total amount, debit sales for the net sale and credit sales tax payable. If the customer pays within the allotted discount period, decrease the total amount owed by crediting accounts receivable for the total discount, including the sales tax reduction. Then credit sales discounts to record the amount of the discount and credit sales tax payable to reduce sales tax owed on the purchase.