Last Word on Sales Tax

Now what?  How do you know what to do to stay within your legal requirements as a retailer? As a retailer you will be filing Form ST-1, Sales and Use Tax Return for each reporting period.  It must be filed on or before the 20^th day of the month following the end of the reporting period.  These dates will be printed on the Form ST-1 that you receive.  For most taxpayers this will be monthly. 

If you pay on time you will be allowed to take a discount on the total owed.  For late payments you will lose the discount and you will have to pay a penalty plus interest.  Like most things these days, you can pay the tax owed electronically through the EFT program.  In addition, instead of filing the return by mail you might be able to file electronically or by TeleFile.

There might be a time when you will make a tax exempt sale and these will need to be supported with certain records.  These include the purchaser’s name and address, the type of transaction (for example, to an exempt organization or for resale), the date, and the amount.

Finally, keeping complete and accurate records will make filing easy.  Sales tax is not really as complicated as it might seem at first glance.

More on Sales Tax

As a retailer you are responsible to know the Sales and Use Tax rules for your state.  For Illinois based companies this includes collecting the right amount of sales tax on taxable sales that you make, documenting tax-exempt sales that you make, paying Use Tax on items purchased and not resold, keeping good records of these transactions and sending sales tax owed with the proper forms to the Illinois Department of Revenue. 

The first step of the process is registering with the state as a retailer.  If you do business in Illinois, have a site or an office in the state or a warehouse from which goods are delivered, or if you sell items at craft shows, fairs or such in Illinois this requirement applies to you. 

As I mentioned yesterday, the rate that applies to retail sales will vary based on the location of the sale.  Form ST-1, your sales tax return, will have your rate preprinted on the form.   The sales tax return is not difficult to complete if you keep good records.

Illinois Sales Tax

Do you sell your work on line?  While it is generally believed that interstate sales are not subject to sales tax this is only true to some extent.  When you shop from an on line catalog the catalog company is required to collect sales tax when delivering goods to a state where they have a physical presence.  That means if you are selling your work on line you should be collecting and remitting sales tax on the art you sell in state.  I live in Illinois and the Illinois’ system is exceptionally complicated.  There is a base rate that is broken down into a percentage for the state, city, county and in addition, the local government might impose a percentage as well.  The rate in Illinois could be anywhere from 6.25% to 11.5%.  The tax is also broken down into four divisions, Retailers’ Occupation Tax, Use Tax, Service Occupation Tax, and the Service Use Tax.  An artist selling in state is required to pay the Retailer’s Occupation Tax who then in turn collects the Use Tax from the consumer offsetting the amount and remitting it to the Illinois Department of Revenue.

Estimated Taxes

Yesterday I mentioned the need to classify equipment purchases and other types of asset acquisitions differently for tax purposes even if you are using cash basis accounting.  It’s still early in the tax year so I think it would be wise to talk a bit more about taxes. 

When you were working as an employee, and maybe you still are, you had a certain amount of taxes deducted from your gross pay.  These deductions might have included federal, state, and local income tax, FICA, Social Security and Medicare and were reported to you and the government on form W-2. 

If you have been hired as a contract worker it’s likely that no taxes were withheld from your income and the full amount paid to you would be reported on form 1099-Misc after the close of the year.  If you are selling your work to the end user you are also liable to claim the income as taxable income also from which no taxes were withheld.  If no tax payments are made to the government throughout the year you could end up with a hefty tax bill and penalties to boot.  To prevent this you will make estimated tax payments that can be calculated using form 1040-ES.  To learn more about making estimated payments go to http://www.irs.gov/businesses/small/article/0,,id=110413,00.html.  Payments can be made through the EFTPS system as often as weekly so long as the full amount estimated to be owed for the quarter is paid by the due date.

Assets and Depreciation

In yesterday’s blog I mentioned asset acquisition and depreciation.  Just to backtrack a bit, when you start up your business you will decide whether you will use the cash method of accounting or the accrual method.  Most small businesses (and artists) use the cash method.  What this means is that you will include your income and your expenses in the year that you actually pay for them.   The accrual method is a little more complicated.  You become liable for your expenses when they occur and you need to report income in the year it is earned.  The accrual method is mostly used by large businesses and those with significant inventories. 

Even though you have chosen to use the cash method, any assets that meet the requirements for depreciation or amortization will not be fully expensed at the time of payment or purchase.  This is an exception to the cash method of accounting that is required for tax returns.  There is a Form 4562, Depreciation and Amortization, that you will complete along with your Schedule C, Profit or Loss from Business.  On this schedule you will list your property, its value, the term for depreciation, the method, etc.  Again, this is another good reason to have a good tax accountant even if you are keeping immaculate records.  Property owned can have different classifications regarding its useful life which determines how much of an expense you can take in one year.

Cash Outlays

Today let’s look at the entries for a simple purchase of supplies and an equipment purchase.

The entries you make for office expenses you incur are pretty straight forward.  When you make a purchase your cash is decreased (credit) and the expense account is increased (debit) for the same amount.

                                    Debit               Credit

Office expense             $45.00

Cash                                                    $45.00

If you put the same expense on your credit card it would look like this:

Office expense            $45.00

Credit card payable                             $45.00

Then when you pay your credit card you will debit the credit card payable account and credit cash.  If you incurred any associated fees (interest) your credit to cash would be that much more and you would have a debit to interest expense for that same amount.

Credit card payable     $45

Interest expense             $3

Cash                                                    $48

If you make a significant purchase of office equipment that will be used for more than one year the transaction is different.  Instead of debiting an expense account you will capitalize the asset by debiting an asset account.  At the time of purchase your profit and loss statement is not effected, just your balance sheet.

                       

                                    Debit               Credit

Equipment                   $2,500

Credit card payable                             $2,500

The depreciation that you take yearly is the expense that is deductable on your business tax return.  Your tax accountant will determine the term and method of depreciation that you use based on tax law.

A Couple of Entries

You sold a print for $30 from your website! Awesome. The payment was made through PayPal which charges you 4% of the total sale. How do you book it? (Not to get confused – always remember – debits on the left and credits on the right)

PayPal disburses directly to your checking account increasing your balance by $28.80. That’s $30 less their 4% fee.

                                 Debit             Credit
Cash                         28.80
Transaction fees          1.20
Sales                                            30.00

This time you sold an original piece at a local art fair so you had to charge sales tax. The charge was for $450 and processed on VISA. Your sales tax rate is 7%. It takes a couple of days for your bank to process the charge and enter it into your checking account. This is the entry on the date of the sale:

Accounts receivable  481.50                       (Sale + Tax)
Sales tax payable                         31.50     (7% of the sale price)
Sales                                         450.00

The bank charged you a 4% processing fee. This is the entry to make when the bank disburses the funds to your account:

Cash                      462.24
Transaction fees       19.26                       (4% of the amount charged)
Accounts receivable                   481.50

At the end of the month you need to file a tax return for sales tax collected during the month. When you send the return with your money this is the entry you will make:

Sales tax payable    31.50
Cash                                          31.50

You can consider the receivable accounts and payable accounts as “holding pens” until you actually receive or disburse cash.

To keep your bookkeeping accurate and complete you just need to think through what all the accounts are that are going to be effected by the transaction, then make sure that the left side (debits) always equals the right side (credits).

A break from the details

My plan for today was to continue with my explanation of bookkeeping entries but having had my hands in fiber most of the day with no thoughts of bookkeeping interfering the creative process I decided to take a little reprieve.  As I was creating I was wondering how much interest there really is in accounting 101.  If you are keeping good records and have contracted a bookkeeper to prepare your financial statements you don’t really need to know how to handle the daily accounting entries.  Then again, if you are familiar with these entries you will have a better understanding of your financial statements and a better understanding of your business and then be more prepared to make decisions down the road. 

I’m going to age myself here but when I started working on a computer it was DOS based.  Because I worked in DOS I understood what the computer was doing.  It was frightful for me to start working in a windows based environment.  Nothing made sense anymore.  I hated it but there was no turning back.  I’m now thankful that I have the DOS background because when something goes wrong I have a better idea about how to fix it. 

So, Accounting 101 it is, tomorrow…

More on Debits and Credits

As we became managers of our own money and opened checking accounts we got the idea instilled in us that when an account is credited that’s an increase and when an account is debited that’s a decrease. That’s simply the bank’s side of the equation of the general ledger account representing your money. Like I said yesterday, each of the types of accounts generally has either a debit or a credit balance. This is what your financial statements look like:

Balance Sheet:
        Assets (debit) = Capital (credit) + Liabilities (credit)
Income Statement:
        Revenues (credit) – Expenses (debit) = Profit (credit) or Loss (debit)*

*At the end of the year the profit or loss is “closed” into the capital account. On a very basic level, capital is the sum of profits over the years and any investments made by you or other investors less any money taken out of the business.

Today I’d like to give you a very general picture of the financial statement of an artist and tomorrow go through some examples of transactions you might make.

Balance Sheet
  Assets
     Cash
     Accounts receivable
     Inventory
     Equipment
  Liabilities
     Accounts payable
     Credit Card
     Sales tax payable
     Deposits from clients
     Loans
  Capital

Income Statement
  Income
     Sales
  Expenses
     Materials
     Small tools/supplies
     Shipping
     Art Fairs
     Workshops
     Advertising
     Bank fees
     Depreciation Expense
     Insurance
     Office supplies/expenses
  Net Income (Loss)

A beginner’s intro to debits and credits

Balanced accounting is like a math equation, one side must equal the other, the debits have to equal the credits. All of your financial accounts (assets, liabilities, equity, income and expense) have a normal balance as either a debit or a credit. When you increase one account, another account has to be increased to keep everything in balance.

As a simple example let’s say you sold a print of one of your art pieces for $30 cash. Cash is an asset account (it’s what you own) and Sales is an income account. Asset accounts normally have a debit balance and Income accounts normally have a credit balance. To record this transaction you would debit (increase) cash and credit (increase) sales each for $30. The equal increase to both accounts keeps everything in balance. Sounds simple, right? It is, as long as you have a good chart of accounts, that you know what type of account you are increasing or decreasing and that you always keep everything equal.