Taxes are like an annual subscription that you pay to your country for living and doing business there.
As an eCommerce business owner, you might not want to pay them. But, you do so anyway if you like your freedom and staying out of jail.
In this post, we’re taking a closer look at the most common U.S. eCommerce tax laws and what you need to know to stay compliant.
Federal and state income taxes
Federal and state income taxes apply to every business, not just eCommerce companies.
Federal income tax is a tax that is levied on the income of an individual and the profit of a business. It is used to fund the federal government and its various programs and services.
State income tax works in a similar fashion. All but 8 states have some form of a state income tax. The only states that do not have one are Alaska, Florida, Nevada, South Dakota, Texas, Tennessee, Washington, and Wyoming. However, even in these states, there may be local income taxes that apply in certain regions or higher property taxes.
These taxes are rate-based. So, the amount of federal and state income tax that you owe will depend on your business and personal net income. For example, a solo eCommerce entrepreneur doing $50,000 in sales in a sole proprietorship will be taxed in a lower tax bracket than the founder of a multi-million dollar eCommerce business.
As a business owner, it is recommended and required that you pay these income taxes as quarterly estimated tax installments. You will also need to file your tax return with the Internal Revenue Service (IRS) every year, either mid-March or mid-April depending on how your business is organized. A six month extension to file is typically automatically granted but the IRS still wants their money by the original March or April deadline. It is advisable to work with an accountant that will provide quarterly tax estimates to help manage your cash flow.
US Sales Tax
The most important eCommerce-specific tax is US sales tax. And it is also the most complicated, particularly if you have warehouses or employees in multiple states.
eCommerce businesses are required to collect and pay sales taxes on the products and services they sell, just like any other business, in 46 states.
Pro Tip: The only four states that do not have a state sales tax are Delaware, Montana, New Hampshire, and Oregon.
This tax is typically collected by the merchant at the time of sale and then sent to the appropriate state or local tax authority. The sales tax rate varies depending on the location of the business and the location of the customer.
For example, a business based in Salt Lake City would charge and pay a different sales tax rate than another business that is based in Des Moines.
Understanding sales tax nexus
To understand where you need to register, file, and pay sales tax, you need to determine which cities and states you have nexus in.
The specific criteria for establishing sales tax nexus vary by state, but they typically include factors such as having a physical presence in the state (e.g. a store, warehouse, or office), having employees in the state, or exceeding a certain number of sales or transactions in the state.
Once a business has established sales tax nexus in a state, it is required to collect and remit sales tax on all sales in that state to avoid getting fined for noncompliance.
The amount that you pay in sales tax gets more complicated as some cities and states charge different tax rates for specific product types like food or alcohol.
Registering and filing sales tax
We recommend registering and filing sales tax in any city and state where you have nexus. The specific process for how to register varies by state.
Because reporting and filing sales tax can get complicated and time-consuming fast, use a third-party app, like Avalara, to make the process of calculating and reporting the total amount of sales tax owed simpler.
In addition, up until 2018, many states were more lenient around sales tax, particularly for eCommerce businesses doing under $1 million in revenue.
However, this started to change when the United States Supreme Court ruled 5-4 in South Dakota v. Wayfair that states can mandate that businesses without a physical presence in a state with more than 200 transactions or $100,000 in-state sales collect and remit sales taxes on transactions in the state. Today 45 states have adopted their own version of South Dakota’s law with varying transaction and sales requirements.
Related Reading: Our US Sales Tax Compliance Guide
Digital Goods Tax
If you sell digital products, another tax to pay attention to is the digital goods tax, which is a tax that is levied on the sale of digital products, such as ebooks, software, online courses, or other digital content.
The vast majority of states have implemented a tax on some or all digital goods. For an in depth resource to see what you might need to pay in your state, check out this guide from Avalara.
How to stay compliant as an eCommerce business
If you want to avoid an unpleasant surprise at tax time and additional penalties, we recommend doing the following:
- Registering and filing sales tax returns in any state where you have nexus. Engage your accountant to conduct an annual nexus review.
- Collect the appropriate sales tax from your customers at the time of purchase.
- Make sure your ecommerce platform is configured properly when it comes to collecting sales tax. (Hint: Depending on the state, don’t forget to collect it for shipping!)
- Keep up-to-date books and financial records.
- When in doubt, ask your accountant about any tax or compliance questions.
- Mistakes happen. If you found out, you paid too little (or weren’t fully compliant), be proactive about fixing it. Work with your accountant to apply for a voluntary disclosure agreement with typically limits the lookback period as well as penalties.
- Considering opening a separate bank account for all sales tax fees. You may even want to adopt a cash flow management system, like Profit First.
Looking for an eCommerce accounting firm or have a question about sales tax, schedule a free call with our team here.