We all know that paying taxes is part of the reality of doing business. It isn’t a fun task, especially if you’re in ecommerce and selling across multiple states and channels. There are many business-jeopardizing pitfalls in the swamp of over 12,000 tax codes in the United States.
Here’s what you need to know about income and sales taxes to save money and avoid any nasty surprises when tax time rolls around.
Federal and State Income Tax Overview
Businesses have to pay federal income tax every quarter based on when they generated the income. We’ve listed the due dates for each quarter below:
|Federal Income Tax Generation Period||Tax Payment Due|
|Jan. 1 – April 1||April 15|
|April 1 – May 31||June 15|
|June 1 – Aug. 31||Sept. 15|
|Aug. 31 – Jan. 1||Jan. 15|
Source: Internal Revenue Service
For starters, if your business is small enough, it might qualify as a “hobby income” instead of a business entity. It’s less about how much you make and more about how you manage your operations — check out these 9 distinguishing factors to see if your online store qualifies as a business or a hobby.
Qualifying taxpayers can deduct hobby expenses up to the amount of hobby income, but a loss cannot be deducted from other incomes. To learn how to itemize deductions for hobby income, read Publication 535 (Schedule A, Itemized Deductions).
For serious sellers who don’t qualify for hobby income, tax rates and forms vary depending on your business structure (sole proprietorship, LLC, etc.). Some states have no state income tax, but if your state does, keep in mind that state and local taxes can be offset by itemizing deductions on your returns.
With the 2017 Tax Cuts and Jobs Act, we now have a flat 21% tax rate for corporate profits — but 75% of businesses in the U.S. are not corporations. These small and medium-sized businesses are considered pass-through entities (a.k.a. “flow-through”), whose owners pay personal income tax rates with deductions up to 20%. The new law caps this income at $157,500 for individual taxpayers and $315,000 for married taxpayers filing jointly. Check out these 12 ecommerce tax deductions you don’t want to overlook.
Ecommerce Sales Tax Overview
If you’re an online retailer that sells over multiple channels, sales taxes can quickly turn into a nightmare. It gets even more difficult for those retailers selling products or storing physical inventory across multiple states because of the tricky subject of nexus.
A nexus is basically anything that connects the seller to a particular state, with different states using different criteria. After the 1992 Quill Corp. v. North Dakota case, states can’t collect tax from sellers without a nexus. When they do have this nexus, state and local tax rates vary and sometimes depend on the county, city, or district.
Further complications have arisen with the 2018 landmark case South Dakota v Wayfair, Inc. As we explained in our analysis of what this means for online retailers, the case pushed the boundaries on what states can consider a nexus, widening their nets to include more ecommerce sellers in-state sales tax.
It’s your responsibility as a business owner to collect taxes from buyers and file them with the right people. First, you need a permit for each state you have a nexus with — here’s a list of links for registering in each individual state. You can do this by sending in your business info and Federal Employer ID if you have one.
How you actually charge tax from customers depends on your ecommerce platform. Many online marketplaces and shopping cart software automate sales tax calculations or even let you adjust the calculation based on your specific tax obligations. Be sure to keep track of the different due dates for filing and remitting to avoid compliance issues — you might even be eligible for discounts on early remissions!
Sales Tax Sourcing: Origin vs. Destination
States must decide whether to apply sales tax based on origin or destination: origin refers to where the business is located, while destination refers to where the product is shipped, i.e., the customer location. Most states opt for destination.
To make things tougher, different states have different rules when it comes to out-of-state selling. This fragmented system of mixed taxation can be confusing at the best of times.
Here are some basic points to keep in mind:
- In-state sales should be taxed if your state has a sales tax. The final rate depends on any local taxes;
- If you and the buyer are both in destination-based tax states, the tax rate goes with the buyer’s shipping address;
- When you’re selling from a destination-based tax state into an origin-based state, no sales tax is charged unless you have a nexus in their state;
- If you sell from an origin-based state, the customer pays the rate in your state, even if their state taxes by destination.
Dropshipping and Third-Party Fulfillment Taxes
If you dropship or use a third-party service like Fulfillment by Amazon (FBA), your sales tax permit can also double as a resale certificate in most states. Presenting this certificate when you buy the product lets you avoid paying sales tax on goods that you plan to resell.
Also, be aware of your inventory and the shipping origin of your products. If they’re stocked in a different state, there’s a good chance that you have a tax nexus in that state and may have to charge sales tax.
Although third-party fulfillment services like Amazon do their best to shield sellers from state sales tax, sellers are still required to comply with tax law or face audit. Review the state laws for all your fulfillment centers to make sure everything is above board and you’re registered where you should be.
The Taxing Task of Tracking Taxes
Just when you finally get the hang of recent tax laws, they change everything. It’s important to remember that tax laws are always fluid: the only way to stay compliant is to keep checking back on changes, updates, and new cases. When it comes to ecommerce sales tax, we’ll always publish the latest news on our blog, so keep reading to stay up to date.
Interested in more accounting tips? Check out these 6 common ecommerce accounting mistakes you should avoid.
Editor’s Note: This blog post was originally published April 2018 and was updated in January 2021 to reflect more accurate and relevant information.