Regardless of whether you sell through Amazon, dropship, wholesale, or sell D2C, staying compliant at tax time can be especially frustrating for ecommerce entrepreneurs.
In this post, we’ll examine three of the biggest areas where entrepreneurs run into problems, including:
- Sales Tax
- Hiring employees, contractors, and freelancers
Is there a difference in the tax process for FBA sellers, dropshippers, and ecommerce shops?
This is one of the biggest questions we get asked, and we want to address it before we dive into the details.
The answer to this is still being debated within ecommerce communities.
This is because when you sell on a platform like Amazon, it’s not clear if the person buying your products is your customer or Amazon’s.
However, the tax process shouldn’t differ regardless of the state(s), which you may require to register due to nexus (More on that in the next section, or if you dropship, sell on Amazon or directly from your own warehouse.
Collecting sales tax
The rule of thumb for online sales is you have to collect sales tax from online customers in states where you have a physical presence, or “nexus.” Your business may have a “nexus” if any of these key factors apply: you have a storefront, office, a warehouse, or have exceeded $XX amount in sales in the state (a.k.a economic nexus).
Once you start selling online, you must first determine nexus, and then collect and remit taxes to be compliant. This typically starts in the state where your business is registered. Most states impose sales tax, but several such as Oregon and Alaska, do not. If your home state charges sales tax, then you will likely have “nexus” in the state.
Sales tax registration in specific states
If you have “nexus” in a state, you must register for a sales tax permit. It’s important to understand what the requirements and potential liabilities are for the specific state you have a “nexus” in.
An accounting professional, state sales tax office, or government website are all great resources to guide you through registering to collect sales tax. Each state is different, so it’s important to seek out information relevant to your state.
Pro Tip: It’s illegal to collect sales tax without a sales tax permit within certain states.
Origin v. Destination Sales Tax
Once you’ve determined your business’s “nexus” status, you’ll need to know the difference between origin and destination sales tax.
Essentially, if your home state is origin-based, you’ll need to charge everyone in your state the rate for where your business is located.
If your home state is destination-based, then you’ll need to charge everyone in your state the tax rate where the item is being delivered. Keep in mind that states have different rules for out-of-state sellers.
Pro Tip: Contact a qualified accountant for a sales tax analysis to understand what states apply to your business and why. Once you’ve identified that there’s a requirement to collect, you must register in those states and immediately begin collecting sales tax from those customers to avoid any fines or penalties.
Notice and Report Laws
Some U.S. states have “notice and report” laws, which are similar to states with economic nexus laws. The difference is they require sellers to collect sales tax for their state when they meet certain thresholds instead of simply having a physical location in their state.
For example, the state could require sellers that do $100,000 or more in revenue in their state to register for sales tax even if they don’t have a physical presence in their state.
Pro Tip: Check out this guide from TaxJar, which goes into detail on “notice and report” laws and the states that utilize them.
Retailers often have the opportunity to buy items to resell without paying sales tax at the time of purchase. Resale certificates, otherwise known as a reseller’s permit, are presented to the vendor at checkout. As a seller, you may also accept a certificate from another retailer. This TaxJar post gives more details about resale certificates and when you can use them.
Automating the sales tax handling process
In addition to automating the sales tax compliance process, these apps can also help you find sales tax exemptions.
Sales tax exemptions are beneficial, but only if you aren’t wasting your time identifying them. If the benefits are no longer outweighing the amount of time you spend identifying and involving yourself in the task, then it’s time to outsource through software or a service provider.
Pro Tip: When looking for sales tax exemptions, such as sales tax holidays in specific states during back to school time, you can also find the information you need by going to the state agency’s Transaction Privilege Tax Reference Guides. Many amnesty days or discount days will be listed on the state’s website or email list. A less time-consuming way to review the information is to use the guides provided by both Avalara and TaxJar.
Finally, you’ll want to maintain a balance and not become too hands-off. We recommend running a quality check of the data being pulled from sales channels to see that operations are running the way that you’ve set up or have been instructed by an expert to execute.
Creating tax reports
As an ecommerce seller, you’ll need to file and report your tax obligations along with your estimated payments.
Here are some tips to make it run smoothly.
Get familiar with the reporting and filing frequency in each state where you have “nexus”
Reporting and filing frequency can vary from state to state, but it’s often related to the volume of sales instead of state “nexus.” For example, smaller sellers with lower volumes of sales will generally file quarterly taxes. Larger sellers would be responsible for filing and reporting their sales tax on a monthly basis. It’s still important to check with your individual state for sales tax regulations and requirements for paying sales tax.
Reading and reviewing sales tax reports
Automated tax software is capable of generating a variety of useful reports. Two important numbers to look at during reporting include what the sales were for the period and the amount of sales tax collected. Reports will often go by state, but there are different tax rates for various counties and cities. For this reason, you should go through an accountant or use tax software, like Avalara or TaxJar, which are capable of generating these reports.
These reports should be reviewed on a monthly basis at a minimum.
Pro Tip: It’s important to be mindful of what your own specific trends look like within one jurisdiction from one period to the next. This helps to ensure you aren’t paying a consistent amount to a specific jurisdiction, and all of a sudden, the amount is two or three times more without a shared influx in sales. Paying close attention to your numbers will help prevent costly mistakes like this.
Understanding employment taxes
When hiring someone to join your team, you need to understand the capacity the person is working at.
Should they be classified as a full-time employee, part-time employee, or freelancer?
If you hire an employee, you’re responsible for a portion of their taxes, whereas contractors and freelancers are responsible for withholding their own taxes.
Whether you have full-time employees, part-time employees, or freelancers, you’ll want to follow all employment laws in your state. This means, among many other things following minimum wage laws, paid time-off mandates, and paying applicable taxes for employees. For freelancers, you’ll need to submit a 1099 form for all workers at year-end.
Pro Tip: The distinction between an employee and a freelancer is nuanced. We recommend chatting with an employment attorney or accountant if you have any questions.
Collecting sales tax for ecommerce businesses can get complicated. This is particularly true when you have nexus in multiple states.
To get started, check out our free ecommerce toolkit, which can help you establish a solid foundation and understand any potential tax liabilities. Download it here.