Taxes for eCommerce
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Taxes can be super confusing, especially when you are an entrepreneur starting your first eCommerce business! That’s why we’ve broken it down for you, taxes shouldn’t stress you out but they are super important!
If you just started your business, don't worry about taxes too much, like I said before, it can get confusing, but don't panic! Your main focus should be on getting those first sales and proving your concept and site, then you can circle back to taxes!
Remember: it’s always a good idea to reach out to a tax professional in your state for more details on how to comply with US tax rules.
There are two types of taxes, sales tax & income tax…
What is sales tax?
Sales tax is a small percentage of a sale tacked on to that sale by an online retailer (BigCommerce.com). As an online retailer, you are responsible for charging your customer the correct amount of sales tax for their state and pay the state back for that sale.
Is sales tax different from income tax?
Yes. It is a good rule of thumb to put 30% of your profits aside for tax season.
Should I get a Tax ID
Getting a tax ID or EIN is super easy, free and a great thing to have. It allows you to separate your business as a sole proprietor from you. Shopify will ask you to enter your social security number for tax purposes but you if you have one created, can enter your tax ID instead. Some suppliers may also ask for your tax ID. Click here to learn more about what a tax ID is and how to get it.
What should I have set up before making sales?
It is a good idea to have a tax ID and include your sales tax in your prices, at least until you have proven your store and your concept, but it isn’t a bad idea to look into the rules of your state by going to your states official website. Once you hit $20,000 in sales or 200 orders you will be required to file a 1099-K tax form to the IRS which is your self-employment form.
What does “Nexus” mean?
Nexus essentially means you have a commercial presence to a state, i.e are you doing business there? You either have a nexus or you don’t, it depends on your state. For the most part, you will have a nexus in your own state and will be responsible for taxes there.
If you have nexus in a state, you are legally required to charge sales tax. However, it isn’t that simple, different states have different definitions of what “doing business” consists of. Here are a few examples (quanderno.io):
Physical Nexus
“The original concept of business nexus was a physical presence in the state: a store, an office, a warehouse. This was pretty straightforward, as it referred to a permanent structure in a given location.
Over time, the concept of “physical presence” expanded to include a presence in the state, either temporary or permanent, that generates or helps fulfill sales.
So, you or a sales rep attending an event where you make sales, or even connect with potential customers who convert later — this would count as nexus. Certainly storing your inventory in a state would count as nexus, as well. (In today’s world of Amazon FBA and the like, some states tax the marketplace site, some tax the seller.)
There’s even the possibility of a “trailing nexus,” which means even after you’ve picked up and left a state, the physical presence nexus will still apply for a certain period of time. Only a few states have trailing nexus, which last anywhere from one month to a year.” (quanderno.io)
Affiliate Nexus
“You have an “affiliate nexus” if you’re affiliated with a business or individual in the state and sales are generated from this connection. Referrals are the most common revenue source associated with this nexus.
States that have some version of an affiliate nexus rule are Arkansas, California, Connecticut, Georgia, Illinois, Kansas, Maine, Missouri, Minnesota, New York, North Carolina, Pennsylvania, and Rhode Island. Many of these states have minimum sales thresholds, so the nexus (and tax obligations) only applies once you surpass a certain amount of gross sales.” (quanderno.io)
Click-Through Nexus
“Similar to affiliate nexus, a click-through nexus exists when your business receives sales referred by another business located in the state. If you run ads or links on an in-state website, which channels potential customers and new business to you, this counts as the aptly-named click-through nexus. (quanderno.io)
States that have some form of click-through nexus on the books include Arkansas, California, Connecticut, Georgia, Illinois, Kansas, Louisiana, Maine, Michigan, Minnesota, Missouri, Nevada, New Jersey, New York, North Carolina, Pennsylvania, Rhode Island, Tennessee, Vermont, and Washington. Again, most states have a minimum sales threshold for this nexus, so the rule only kicks in once you surpass a certain amount of gross sales.” (quanderno.io)
Web cookies
“A few states consider software or web cookies on in-state devices as a business nexus. These include Massachusetts, Connecticut, Rhode Island, and Ohio. In all cases, the sales thresholds for this nexus are pretty high.” (quanderno.io)
Economic Nexus
“This one is broad, and will likely become THE nexus to rule them all, making obsolete all other tedious rules (i.e., those listed above). (quanderno.io)
The rule? Any kind of economic activity could trigger nexus, once it reaches a certain amount. Generally, states with this nexus have a threshold in place. The common threshold is $100,000 in annual sales or 200 separate sales transactions, but exact numbers can vary by state.” (quanderno.io)
How to comply:
As per quanderno.io and bigcommerce.com, the next steps are the following:
Register for a sales tax permit in that state: You can either go to your state's Department of Revenue website or use the Streamlined Sales Tax Registration System.
Charge sales tax to customers in that state: Shopify can help you set this up, you should already be charging sales tax for customers who purchase in your home state. Keep in mind that Shopify doesn’t pay or remit the taxes for you, they simply tell you how much you will owe for that transaction. You can read more here. When you have a transaction that calculates taxes, it will look a bit different than other transactions, here is an example:
Origin & destination based Sales Tax sourcing: each state comes up with its own tax laws. They can choose between being an origin or destination-based sales tax sourcing. If they are origin-based sales tax sourcing, the online seller charges sales tax based on the tax rate of the state of their business. If they are a destination-based tax sourcing, they collect the sales tax based on the destination state of the order.
Bigcommerce.com examples:
“Origin-based sales tax collection example
Lou lives in and sells online from his home in Irving, Texas. Texas is an origin-based sales tax state, so when Lou makes a sale to a buyer in Archer City, Texas he charges that customer his home rate of 8.25% in Irving. He does not charge the customer the Archer City rate.”
“Destination-based sales tax collection example
Amanda lives in and sells from her home in Stamford, New York. New York is a destination-based sales tax state, so when Amanda makes a sale and ships an item to a buyer in Buffalo, she is required to charge her customer the Buffalo sales tax rate. She does not charge the buyer her home sales tax rate in Stamford.”
File sales tax return in your state: Head on over to your state's official website for more information on this. When you register, you will be instructed to pay your sales tax either monthly, quarterly, or annually. Your state website will have all the necessary instructions on how to file this information and whether they require calculations from just your state or all states in which you sell items.
How can I keep track?
It is super important to keep your business and personal finances separate. This will make it much easier to see how much you are spending, what you are profetting and will make tax season much easier. Here are a few suggestions.
Set up Shopify to collect taxes
Open a new bank account
Purchase an accounting software
Tax Reporting
Hopefully, this helped clarify some tax information but it is always a good idea to reach out to a local tax professional to get more personalized information about your business and state.
Disclaimer: eCom Babes 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.
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