We all know that paying taxes is one of the most inevitable parts of life. What is not always so clear, however, is when you need to pay taxes and how much you currently owe. These questions are often no easier when it comes to understanding how to charge your customer for taxes. Hopefully this article can provide some clarity.
Some taxing challenges
There are currently millions of pages of legal tax law on the books, creating challenges for business owners of all stripes. Even those with relatively “simple” business models are often wondering whether they are paying their taxes correctly and on time.
One of the most common challenges faced by business owners is whether or not to apply taxes to an invoice. Invoices often represent a significant portion of all financial transactions. When you issue one, does this create a tax obligation for the issuer? The recipient? Both? Neither?
Unfortunately, the answer to this question is one that is highly situational. Whether you need to pay taxes on an invoice will depend on the legal status of both parties involved, the nature of the invoice itself, and a variety of other factors. Having accurate and correctly taxed invoices will help your business improve its reporting and payment cycles, along with other functions like invoice factoring. Because applying taxes to an invoice can be difficult for some people, you may want to consider working with a professional accounting firm.
If you are wondering how to apply taxes to an invoice, you are certainly not alone. Below, we will discuss the most important things you need to know about applying a tax to an invoice. By taking the time to learn about this important process, you can put your business in a better financial position.
Do you have to put tax on an invoice?
Whether you need to pay taxes on an invoice will depend on what the invoice represents. If the invoice represents a bill of sale—and, as a result, is subject to sales tax—then yes, you will need to include taxes.
The first line of the invoice should include the total charges, including all services and goods that have been rendered. Even if the goods and services have not yet been paid for (and thus qualify as accounts receivable), an invoice can still be used to show that a transaction has, in fact, occurred.
The next line on the invoice should include the tax amount. Separating the taxed amount from the billed amount will be useful come tax season for both the invoice issuer and the invoice recipient. Any tax exemptions or adjustments should also be included. Be sure to include the applicable tax rate, whatever that might be. Most sales taxes are imposed on a state or local level, but other taxes and fees might also apply (and should be included in the invoice).
Finally, the invoice should also include any reductions, additions, or other types of changes. This might include a discount, a late fee, and various other types of adjustments. Ideally, your invoice will make it easy for a neutral (outside) party to determine when the transaction materialized and how much has been paid or will be paid in the future.
Different types of invoices
There are many different types of invoices that might emerge over the course of doing business.
Standard Invoice: the standard invoice is usually issued by a business to their client or customer. It should include the contact information for all parties, an invoice number, the corresponding tax information, and explain whether any money is still owed.
Credit Invoice: a credit invoice is issued alongside any crediting transactions, such as a refund for a customer. The amount being credited will be listed as a negative value.
Debit Invoice: a debit invoice, also called a debit memo, can be used to make small adjustments to standard invoices. If any taxes are paid or applied, they should still be included.
Timesheet Invoice: a timesheet invoice can be used in instances when the individual is getting paid by the hour. This can include consultants, accountants, lawyers, and many other types of individuals. Unless the recipient is employed by the company, you can choose to let them handle the taxes on their own (they might need a 1099 or other tax form).
To summarize, if a transaction generates any sort of immediate tax obligation (anything other than year-end income tax), then the issuer should include all corresponding tax information.
How to calculate tax on an invoice
Understanding how to apply tax to an invoice can help your business continue operating with ease. Here is how to calculate tax on an invoice:
Step One: identify the type of transaction taking place. If the invoice represents the sale of goods or services, you will need to apply the sales tax.
Step Two: determine what the current applicable sales tax is. Your accountant should be able to easily answer this question, but if you are working on your own, be sure to check with all relevant jurisdictions your business is operating in.
Step Three: add the sales tax rate to 1 and multiply by the total sale (example below).
Step Four: clearly list the added tax on the invoice, including the total tax, the new total, and the tax rate being used.
Suppose that you are issuing an invoice for $200, and the current tax rate is 7 percent. To determine the new total, simply multiply the $200 by 1.07 (1 plus the tax rate). In this case, the new total would now be $214.
Invoice tax best practices
Paying attention to these common practices may help your business improve its current financial performance and, ultimately, improve its bottom line.
Invoice Factoring: invoice factoring involves selling your outstanding invoices for a significant portion of the current cost. This helps you collect immediately on your invoices and access the cash you need for your business to grow.
Maximum Information: as a general rule of thumb, if you are wondering if you should include a piece of information (such as invoice tax) on the invoice, you probably should. It’s better to over-explain than to leave your clients wondering.
Think about Timing: when you send an invoice will depend on the kind of invoice you are issuing. This might be after the purchase, after project completion, at specific milestones, or on a predetermined basis. Regardless, be sure that your invoice practices are predictable and clearly explained.
Learning how to apply tax to invoice can help your business improve its communication with clients, improve its reporting standards, and also make it much more likely you’ll be able to collect on existing accounts. As long as invoicing remains an important component of the business cycle, it will be important to find ways to enhance your current invoices and align them with industry standards.
Fundbox and its affiliates do not provide tax, legal or accounting advice. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. You should consult your own tax, legal and accounting advisors before engaging in any transaction.