Adjusting Sales Tax by Item

Adjusting Sales Tax by Item

Sales tax tracking is automatic and runs smoothly if you setup and operate QuickBooks correctly. However, if your QuickBooks file was not set up correctly, or if the Sales Tax feature has not been properly used in transactions, you will probably have a significant amount of troubleshooting to do in order to diagnose and repair the problems.

There are several ways to adjust the sales tax payable account in QuickBooks. You can use a Journal Entry, or you can create a transaction directly in the Sales Tax Payable account register, or in QuickBooks 2002 and above, there is a new feature called Adjust Sales Tax. However, all three of these methods for adjusting sales tax produce essentially the same result a journal entry that adjusts sales tax payable and offsets the adjustment to another account. If the purpose of your adjustment is to record government-allowed discounts, interest, penalties or rounding, any of these methods works just fine. You can think of all these adjustments as “sales tax return adjustments” because they all are something that you calculate and record somewhere on the sales tax return.

However, for all other types of adjustments to sales tax (e.g., adjustments that bring the balance of each sales tax item up to some known amount), you'll need to adjust Sales Tax Payable in a way that causes both the Sales Tax Payable account and the Sales Tax Items to reflect the change.

In this case, do not use a Sales Tax Adjustment, a journal entry or a register transaction to adjust Sales Tax Payable. If you do, the Sales Tax Liability report, and the Pay Sales Tax screen will show a positive or negative offset on a separate line for your sales tax vendor with “Other” after the vendor name (see Figure 1). The problem here is that although the total for the sales tax vendor is correct, the sales tax due for each Sales Tax Item is still overstated.

Figure 1 Sales Tax Liability report with a $5000 adjustment using normal methods.

So, since the normal methods won't produce the result we're after, we have to set up the following:

-  A “clearing account” called Adjustment Clearing and a customer called Accounting Adjustments.
Creating a special account and customer helps you create reports later that focus in on these types of adjustments.

-  An Other Charge item that points to the Adjustment Clearing account.
This allows us to use the clearing account on sales forms.

-  A sales tax item called No Tax.
This allows us to put sales tax items in the body of the sales forms, and it ensures that sales tax will not be “doubled” on our forms.

-  A Sales Tax Code called ADJ.
This code will help us isolate these types of adjustments on reports.

To create the adjustment, follow these steps:

Step 1.   Create a Credit Memo and enter the “No Tax” Item in the Tax field at the bottom of the Credit Memo (see Figure 2).
We're actually creating a “zero-dollar” Credit Memo with the sales tax items in the body of the form and with the No Tax in the tax field.

Note
In this example the amount of sales tax is being reduced, so we use a Credit Memo. If you need to increase (credit) Sales Tax Payable by item, perform these same steps but use a Sales Receipt instead of a Credit Memo.

Step 2.  In the body of the Credit Memo, enter the Sales Tax Item (or Items) that needs to be credited. In the Amount column, enter the total amount of the debit that applies to that item (see Figure 2).

Step 3.  Using the “Sales Tax Clearing” Item, enter an offset amount to bring the Credit Memo balance to zero (see Figure 2).

Figure 2 Credit Memo to Adjust Sales Tax by Item. This reduces sales tax by item.

Step 4. Click Save & Close to record the adjustment.
The Pay Sales Tax screen (and Sales Tax Liability Report) now shows the correct amounts for both Santa Clara and Contra Costa (see Figure 3 and 4).

Figure 3 The Sales Tax Liability Report now shows the adjusted balance for each sales tax item.

Figure 4 Each Sales Tax Item shows the correct amount on the Pay Sales Tax screen.

Step 5.  Create a journal entry to clear the balance in the Adjustment Clearing account, using the appropriate account(s) as an offset. In this example, the client had paid all of the sales tax by check and they coded it to “Sales Taxes Paid” expense (a common mistake), so this adjustment credits that account.

Figure 5 A journal entry that clears Adjustment Clearing to Sales Taxes Paid.

While this trick is not always necessary, it is often very important that all of the reports in QuickBooks produce accurate information. In order to preserve the reports, you need to adjust Items as well as accounts.

Since journal entries, sales tax register entries and sales tax adjustments don't allow you to affect sales tax items, this solution uses a Credit Memo (or Sales Receipt) to produce a "true" Sales Tax Liability adjustment.