This is the fourth and final article in my current "absorption" series.
First of all, keep in mind that absorption, in most states, is illegal. In fact, it’s often defined as a misdemeanor. However, I’ve never heard of anyone going to jail on this. Often the attitude is, "Hey, the state got their money. What's the big deal?" As we've seen previously, there are problems. But the problem for today is that the seller isn’t actually remitting enough taxes to the state on the sale.
Let’s assume the sales tax rate is 7%. Joe sells a machine to Tony for $100,000. He absorbed the tax because Tony keeps whining about how Frank from Montana doesn’t charge him tax so maybe he’ll buy from Frank instead.
Joe’s not an idiot, so he reports sales to the state of $93,458 and $6,542 in taxes (it comes out to the $100,000 that he actually got from Tony). In other words, Joe absorbed the sales tax into the sale.
But what was the real gross sale to Tony? The invoice (which doesn’t show tax) shows a sale of $100,000. Joe’s records, including the journal entry to back out the tax, show a gross sale of $100,000 and an expense of $6,542.
One of the things auditors do is compare the sales on your books, with your invoices, with the sales you report on your sales and use tax return. The gross sale was $100,000. Which means the tax that should have been reported was $7,000 instead of $6,542. Joe under-reported his sales taxes by $458.
Joe can solve the problem by charging the taxes separately. Then it’s clear what the gross sales were, assuming you are doing the proper accounting on the back end.
Of course, then Tony will buy from Frank. That’s OK, Joe didn’t want his business anyway.
Sales Tax Guy
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