Imagine this scenario: taxes are due next week, and you realize you haven’t updated your books in six months or set aside any money to pay your taxes. You panic and start digging through your finances, trying to come up with the money as quickly as possible. But it’s too late – the deadline has passed, and you’re hit with steep fines and penalties. Your business takes a financial hit, and you’re left feeling overwhelmed and stressed out.
This is just one example of why tax planning is so important for eCommerce business owners.
By proactively managing your taxes, you can avoid costly mistakes and ensure that your business stays on track. Fortunately, we’re here to help.
In this post, we’re walking through the no-frills beginner’s guide to US tax planning as well as how to avoid the most common tax mistakes.
Note: Before we dive in, this post is designed to be educational. We strongly recommend all eCommerce entrepreneurs talk to an accountant or accounting firm, like Bean Ninjas, to get the best advice for their specific financial situation.
What you need to know about setting up a US company
When it comes to setting up a company in the US, there are three main company structures: LLCs, S Corps, and C Corps.
However, the correct legal structure from day one may not be your correct legal structure in year five. So it has to be reviewed every couple of years to see if your structure is appropriate for what your goals are.
Not to mention, there is no one-size-fits-all answer for eCommerce businesses. Besides years in business and company goals, you also need to consider additional factors like if you have third-party financing, have multiple shareholders, if you have any founders or shareholders outside the US, and whether you are looking to sell the company someday. That’s why it is important to talk with a tax professional and a lawyer before setting up your company structure.
Limited Liability Company (LLCs)
With a few caveats, most brand new eCommerce entrepreneurs in their first year of business should start as an LLC as it is the easiest to set up and has the most flexibility from there to change.
As your business grows, becomes more profitable, and your take-home salary gets larger, it can be advantageous to switch from an LLC to an S Corp. This allows you to minimize your exposure to employment taxes as well as increasing wages that may be needed to maximize the Qualified Business Income (QBI) deduction.
While high earners can save a lot of money in taxes with an S Corp, there are added filing requirements and more rules and regulations that you have to comply with.
We’re just going to gloss over C Corps because the vast majority of eCommerce companies do not use this structure for various reasons. The biggest reason is the C Corporation has two levels of tax to get money to the shareholders. The company first pays tax on the profits of the company then the shareholders pay a dividend tax when the money is distributed to the shareholders. This leads to a very high effective tax rate, especially in an exit.
US tax planning best practices
The best tax planning strategy starts with having a good eCommerce bookkeeping process. By keeping track of sales and deductible expenses, tax time is no longer as stressful, and you can save money.
US personal and corporate taxes
Here are the taxes that all eCommerce entrepreneurs need to know about.
US personal income tax
The personal income tax in the United States is a progressive tax, which means that your tax rate increases as your income increases. For 2022, there are seven tax brackets that range from 10% to 37% of taxable income.
The tax rates are determined by the government and change every year. Your taxable income is calculated by subtracting deductions and exemptions from your gross income.
Because the tax rates change every year and the amount you have to pay will vary based on whether you are a single filer, joint filer, or head of household, we recommend consulting with a tax professional.
US sales tax
In the U.S, sales tax is governed at the state level and is added to the price of goods and services at the time of purchase. The tax is collected by the retailer that is selling the goods or services.
For example, if you own a business in a state with a 6% sales tax rate and you sell a product for $100, you would need to charge your customer $106, with $6 being the sales tax.
As a business owner, you are responsible for registering and filing sales tax in any state where you have nexus. This can get very complicated. However, typically you have nexus in any state where you have an office, warehouse, employee or significant sales.
In addition, sales tax rates vary based on the type of products you sell as well as from state to state.
While sales tax is notoriously complicated, we don’t recommend avoiding registering and filing sales tax as states do crack down on this.
That’s why we recommend consulting with an eCommerce accounting firm, like Bean Ninjas, and using a third–party app like Avalara to make the process of registering and keeping track of sales tax collections a little easier.
Once you have employees or switch to an S Corp, you need to pay payroll taxes. Payroll taxes are a type of tax that is withheld from an employee’s wages or salary and paid to the government by the employer. Payroll taxes are used to fund various social insurance programs, such as Social Security, Medicare and Unemployment insurance.
As a business owner, it is important to understand your responsibilities when it comes to payroll taxes. Some of the key things you need to know include:
- How much to withhold: You will need to determine the amount of payroll taxes to withhold from your employees’ paychecks based on their wages or salary and their tax filing status.
- When to remit payroll taxes: You will need to remit payroll taxes to the government on a regular basis, typically monthly or quarterly. You will need to file a return and pay the taxes owed by the due date to avoid penalties.
- What to report: In addition to paying the payroll taxes owed, you will also need to report certain information to the government, such as the wages paid to your employees and the taxes withheld. This information is usually reported on a W-2 form.
Because payroll tax laws vary from state to state and the penalties for screwing it up are high, we recommend using a payroll company like Gusto or JustWorks to take care of this for you.
Capital Gains Tax
In the United States, a capital gain is the profit that results from the sale of a capital asset, such as stocks, bonds, real estate, or a business sale.
Capital gains are taxed differently than ordinary income, and the tax rate that applies to capital gains depends on the length of time that the asset was held and the taxpayer’s income.
Long-term capital gains are gains on assets that were held for more than one year. Long-term capital gains are generally taxed at lower rates than short-term capital gains, which are gains on assets that were held for one year or less.
For the 2022 tax year, the tax rate that applies to long-term capital gains is 15% up to $459,750 for single filers and $517,200 for joint filers. Anything above that is taxed at 20%.
4 most common tax planning mistakes that US eCommerce businesses face
Here are some of the biggest issues that we eCommerce entrepreneurs make, along with how to fix them.
Inconsistent revenue numbers
For starters, if your books are a mess and you don’t have exact sales figures, you won’t know how much to pay in taxes at tax time.
Also, if there is a big discrepancy between your numbers in Xero and your Amazon 1099k figures, for instance, you are also increasing your chance of being audited by the IRS. An audit creates additional stress, anxiety, and fees for your accountant.
A simple way to fix this is to have your accountant or bookkeeper reconcile your accounts each month.
Not saving enough to pay your taxes
With a cash-intensive business and poor planning, it can be easy to use any free cash flow to pay your team or buy more inventory. Then, when tax time rolls around, you are scrambling to figure out how much you owe and how you are going to pay it. If you can’t find enough money to pay your tax bill, you are going to end up on a payment plan and paying penalties.
A simple way to ensure that you have enough money to pay taxes on time is to create a separate bank account just for tax money each month. You may also want to use a cash flow management strategy, like Profit First, too.
Not taking advantage of applicable tax deductions
The beauty of tax deductions is that everything ordinary and necessary to carry out your business can be deducted. Good bookkeeping makes it easy to account for any and all deductions.
In addition, it is a good idea to consult with a tax professional to find any lesser-known deductions that you might be eligible for, like R&D credits. Many people think you have to be in BioTech or Pharma to take advantage of these. However, that’s not the case.
Inaccurate inventory accounting
To effectively track and manage your inventory and tax deductions, it is important to switch to accrual accounting and implement detailed inventory reporting on a regular basis (such as weekly or monthly). This will allow you to accurately determine the amount of inventory you have bought, what has been sold (recognized revenue), and any inventory write-offs (tax deductions).
By setting up the correct company structure, proactively managing your taxes, and staying up-to-date on relevant laws and regulations, you can avoid costly mistakes, maintain financial stability, and ensure that your business stays on track.
Whether you are just starting out as a business owner or have been running a business for years, tax planning is something that you should prioritize. With the right strategies in place, you can minimize your tax burden and focus on what matters most – growing your business.