Tracking Use Tax in Xero

Tracking Use Tax in Xero can be challenging and sometimes cause small businesses to overlook the recording and remittance of Use Tax.

Use Tax is the sales tax that would have been paid on an item if the purchase had been made in the state.

When a company purchases goods from a vendor out-of-state, who does not have nexus in the company’s state, no sales tax is charged. In this situation, Use Tax needs to be recorded and remitted along with Sales Tax.

When setuping up Xero, do not assume that “Tax on Purchases” will capture Use Tax. Unfortunately, it does not. If you use the “Tax on Purchases” option so that Sales Tax is captured in the Bill (after the Subtotal), Xero will create a Debit in the Sales Tax Liability account. Not something you want to do unless you intend to request a credit from the taxing entity (not common for small businesses in the US).

The picture below (using the Xero Demo Company) shows a short-cut for capturing Use Tax and creating a Credit in the Sales Tax Liability account, which can later be used to determine your company’s Use Tax liability for the period.

Invoice-Example,-Use-Tax

  1. In this example, we purchased a $143.17 item from PC Complete (a Vendor that does not have nexus in our state). Since we purchased the item from out-of-state, no Sales Tax was charged resulting in a Use Tax liability for our company. The first line shows the item we purchased and the amount billed.
  2. The second line is where we insert the Use Tax (or Sales Tax that would have been charged if PC Complete was an in-state vendor). In this example, we are taking advantage of the fact that Xero uses four decimal places in the Unit Price. By entering the purchase price in the Qty field and the tax rate (8.25%) in the Unit Price field, Xero will calculate the Use Tax for us.
  3. In the third line, we enter the liability field. In this example, we are using the account “220 Sales Tax” to record the liability. By entering a negative tax rate in the Unit Price field, Xero will create a Credit in the liability account for $11.81.

Looking at the Sales Tax Audit report from Xero, we can see that the bill we just created does not increase the Tax amount.

Sales-Tax-Audit-Example,-Use-TaxAdvanced users may want to create a special “Use Tax” tax rate to group purchases in the Sales Tax Audit Report. The Gross (or Net) information can then be used to enter the purchase amount which you are remitting Use Tax on.

The Sales Tax Audit Report does not show that we have a tax liability as a result of the bill we created. However, when we look at the transactions in the Sales Tax liability account, we can see that we increased the liability by $11.81.

Sales-Tax-Liability-Transaction-Example,-Use-Tax

I hope this simple process enables you to better track Use Tax within Xero and avoid using a separate spreadsheet or failing to file and remit the appropriate Use Tax.

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