For every transaction you process that is subject to sales tax, you pay processing fees on the total amount, including the sales tax. Processing fees paid on sales tax can add up quickly, so improperly deducting credit card processing fees paid on sales tax can be a costly mistake, a fact that many businesses that do their own taxes fail to consider.
Information provided in this article is for educational purposes only and does not constitute tax advice. For tax advice for your business, consult a tax professional.
- Paying Fees on Sales Tax
- What type of businesses does this affect?
- Can I change how I process transactions to avoid paying fees on sales tax?
- Passing Fees to Your Customers
- Effects of Passing Fees
Paying Fees on Sales Tax
When you process a credit card transaction, your customer’s credit card is charged for the total amount of the sale, including sales tax. Transactions aren’t divided into sale amount and taxes. Since the transaction amount is the sum of the total sale and the sales tax, you pay your processing fees on that amount. In a retail environment where sales tax is paid on almost every transaction, the increased processing fees can amount to a substantial yearly expense.
For example, if a retail store has a monthly processing volume of $15,000, pays an average rate of 1.9%, and their state’s sales tax is 6%, $205.20 of their yearly credit card processing fees were paid on sales tax.
15000 x 12 months = 180,000 x .06 = 10800 x .019 = $205.20
If the business in this example improperly deducts their sales tax processing costs, or isn’t aware of the deduction, they’re essentially losing $205.20. That number gets higher quickly as your business grows.
What type of businesses does this affect?
Any business that processes credit and debit card transactions for goods or services that are subject to sales tax can be affected. In particular, businesses that process a lot of card-present (swiped) transactions that are subject to sales tax could see significant impacts. It’s important to be aware of the deduction and to take it properly to ensure you don’t give away money that you’re entitled to.
Can I change how I process transactions to avoid paying fees on sales tax?
There’s nothing you can do to rectify this issue at the point of sale. The logistical obstacles involved in creating a system to accurately divide transactions into sales amount and taxes and only apply the processing fee to the sales portion of a transaction make the prospect all but impossible.
To allow separation of transaction total and sales tax, you would either have to divide transactions based on the honor system prior to authorization, or processing banks would have to perform the additional task of deducting sales tax from your gross processing volume prior to settlement.
Allowing businesses to declare sales tax is impractical due to the likelihood of abuse with such a system. Processing banks would see sharp declines in profits, and businesses could see an increase in tax audits. Additionally, dividing transactions before authorization would take extra time during the transaction process, resulting in unhappy customers.
The second option of modifying the settlement process is more feasible than the first, but not by much. The logistics of creating an accurate and efficient system would likely raise costs and could place unnecessary restrictions on businesses.
The good news is that creating a system to handle sales tax separately really isn’t necessary. Tax professionals are accustomed to dealing with credit card processing expenses and accountants know how to properly declare sales tax processing expense deductions. Losses most often occur when thrifty businesses decide to handle their own tax preparations. If you’re one of these do-it-yourself-ers, enlisting the help of a certified accountant may be something to consider once you start accepting credit cards.
Passing Fees to Your Customers
Proper accounting is the best way to deal with sales tax on merchant account fees, but there is another way to handle this issue: by passing along a portion of credit card processing fees to your customers. Known as surcharges or checkout fees, they can be applied to shift the expense to your customers. However, doing so could cause adverse effects if your customers decide to spend less or stop shopping at your store because they are unhappy with your policy.
If you do decide to pass a portion of your fees to your customers, note that card brands historically forbade surcharging credit card transactions, though a lawsuit has changed that. A few states still forbid surcharges on credit cards, trumping the surcharge provision in the lawsuit. Some states are currently contesting the surcharge bans, and laws can change at any point. Before you decide to pass fees to customers, be sure you know your state or local laws, and consult an attorney if necessary.
One legitimate way to pass credit card processing fees to customers is by offering a discount on cash transactions. In this situation, you would likely raise prices on all of your products by a fixed percentage, and then offer a discount of that percentage for transactions paid with cash. Again, you will need to consider the adverse effects on your customers, since paying with credit and debit cards has become a convenient and preferred method for many people.
Related Article: Rules for Surcharging Credit Card Transactions.
Effects of Passing Fees
Whenever you adjust your pricing model it’s important to track the effects such changes have on your cash flow. Passing a portion of processing fees to your customers may hurt your income more than it helps, especially if sales decrease because of customer dissatisfaction with your new policy. If you do decide to pass a portion of processing fees to your customers, be sure to track customer behavior carefully and be prepared to eliminate your new pricing policies quickly if they prove detrimental.
Shifting fees to customers can be a complex process as you’ll need to ensure your policies are in line with changing laws. You can avoid the issue all together and still not lose the processing fees you paid on sales tax by working with a tax professional. If you’re properly handling sales tax and processing fee deductions come tax time, you’ll save yourself time and money without risking alienating or upsetting your customers.
The credit card companies should hand over the money they took that was collected for the taxing locality. It is not their money once the sale has been completed and the money collected, it is the locality’s! Credit card companies owe big time and they certainly can afford it.
COULD NOT AGREE MORE!
Robert your logic is flawed. The customer pays the correct amount of sales tax and the business pays all money owed to the locality for that sale. The locality is not out any money. It is the business owner who is out or more likely the customer as the expense is passed on as higher prices for the items in the store.
Could someone please clarify if a vendor (store or service consultant such as a home designer) can add the credit card fee based to each item of a purchase then use the total amount of all items as the base to add the tax %?
For example, the designer has charged an increase of each item (say 3 items of one purchase transaction) + the state tax to the total amount of the purchase transaction. I asked if I was being taxed on the up-charge of the credit card processing fee and also asked to clarify why she was up-charging each item to cover the credit card fee when there was only one purchase transaction (not that each item was charged separately to incur a processing fee for each item).
Can someone clarify for the customers’ perspective?
Hi Tina, typically the sales tax is charged on the total, which would include any surcharges. The vendor should be applying the surcharge to the total of the goods/services. If you have questions or think something was done incorrectly, you can contact the credit card company or your state’s Attorney General.
I am a small business in Colorado, we signed an agreement with a California company that provides highway signs (“keep the freeway clean”) in my state of Colorado. I picked an auto-pay on my credit card for monthly payment. They want to charge me “environmental fees” monthly for paying with my credit card. I do not understand why I have to pay this. I can not find anything in CA law.
Please help if you have information on this. P.S. our company only has 11 staff members, if that matters.
You may find our article on credit card surcharges / adding fees to transactions helpful: https://www.cardfellow.com/blog/checkout-fees-charging-credit-card-fees-to-customers/