Starting an eCommerce business is a significant endeavor that requires careful consideration. You can begin selling once you have determined your product, brand, and online presence.
And then it’s time to think about taxes.
From the moment your business starts operating, the federal, state, and local governments want a cut. It’s a necessary cost of doing business, even if that doesn’t make it sting any less.
But there’s good news. Savvy eCommerce entrepreneurs know all the tactics to take away from the tax stress and minimize their tax bill. To get you a head start, we’ve compiled a list of what to do (and not to do) to master your tax obligations and save you precious dollars.
DO understand your tax obligations
The first step to mastering taxes is understanding them. Let’s lay out all of your tax obligations as an eCommerce business.
Federal taxes
The taxes you’re probably most familiar with are your federal income taxes. Depending on your business structure, you’re either filing taxes for your business or completing a Schedule C on your tax return.
Income taxes are based on your earnings and deductible expenses. Sales revenue increases your tax liability while deductions reduce it.
The other primary federal tax obligations are employment tax and excise tax.
Income tax and sales tax are unavoidable. Employment tax is only a requirement once you start paying a salary or wage to an employee, even if that employee is yourself.
Excise taxes are rare. They’re only required to be paid if you sell certain goods, services, or activities. Some examples are gasoline, tobacco, alcohol, or plane tickets (yes, plane tickets).
State and local taxes
Don’t forget about state and local income taxes.
Like federal taxes, the most common taxes you need to pay attention to are income and employment taxes. Like federal taxes, your filing process and tax rate depend on your business structure.
Corporations pay a corporate income tax rate which varies by state. The variation between states is a large reason why so many corporations form in the same condition: it’s tax advantageous.
Many businesses have incorporated in Delaware. This is because they have the most lenient taxes, including not taxing corporations that don’t do business within the state. The costs of incorporating are also some of the lowest across the board.
Then there are sales taxes which are also state taxes. That’s where it can get a bit complicated.
DON’T miss a sales tax nexus
eCommerce businesses typically sell across state lines and even internationally. When you sell a high enough volume to a state, you trigger the sales tax nexus.
The sales tax nexus came into effect with the landmark court ruling in the South Dakota v. Wayfair case of 2018. This resulted in online sellers having to remit sales taxes in the states they had a significant presence.
What triggers a sales tax nexus?
What determined a significant presence was either enough sales or a physical presence. Enough sales can be either an amount of revenue (e.g. $100,000) or transactions (e.g., 100 sales).
Sales tax rules differ by state. The thresholds, tax rates, and reporting requirements all change making it tough to stay on top of.
Staying on top of sales tax
The good news is there are tools that help.
Some point-of-sale systems or payment processors have accessible settings that let you set tax amounts but do not remit taxes on your behalf. This helps automate part of the process,
For a full-service sales tax solution, you’re likely paying out of pocket. For example, TaxJar has a 30-day free trial but starts at $19 per month afterward. Similarly, Avalara has a 60-day free trial and starts at $19 per month.
You’re likely asking if you need the software and, if so, which one is right for you. The answer to both depends on the volume of sales you’re expecting and what tools you’re already using.
Since state thresholds start at $100,000 of sales within the state, you have time to figure out if you’ll need a tool to help. With free trials being offered, you can try out options before committing.
DO separate personal and business finances
One of the most straightforward steps you can take to quell tax anxiety is opening a business bank account.
It’s easy to use your accounts and credit cards to get your business off the ground. But once it turns into a habit, it can turn into a messy accounting problem.
The perks of a business account
Do you know how hard it is to recall what you had for lunch a week ago? Imagine that for your transactions.
It gets even harder when it’s a personal account. Was that Wal-Mart purchase personal or business? What the heck did you even buy?
Having a business account takes away the guesswork—at least part of it. You’ll still need to remember what the transaction was for (consider taking a photo of the receipt for that part).
Business accounts also come with perks like purchase protection and access to loans, lines of credit, and credit cards for when you’re ready to expand.
Most importantly, business accounts are required for LLCs and corporations. They provide liability protection meaning your personal assets are safe if your business is being sued.
Where should I open a business bank account?
There’s no shortage of options for opening a business bank account.
Online banks have become increasingly common. Their lack of a physical location means less costs for the bank and the savings get passed on to account holders with lower fees and minimum balances. Not to mention all banking including account set up can be done from anywhere with an internet connection.
It’s still worth checking out the big names like Chase, US Bank, and Bank of America. Their full suite of business services gives you the best access to credit and perks, especially for larger accounts.
DON’T miss out on start-up deductions.
Did you start your eCommerce business this year? Then you need to know about deducting start-up costs.
What are start-up costs?
Start-up costs are broken up into two categories.
Organizational costs are associated with forming a corporation, partnership, or LLC. These are your filing, legal, and accounting fees and any corporate meetings or temporary directors.
Business start-up costs cover everything else you’d need to do before you’re open for business. It’s a much larger bucket, including market and product research, advertising, consulting fees, equipment costs, etc.
Why do start-up costs matter?
Like all deductible expenses, every dollar spent reduces your taxable income. But start-up costs have the benefit of being amortized. Amortization is spreading a fee over multiple tax years, meaning you can write off start-up costs for up to 15 years.
These deductions reduce your taxable income and, thus, your tax liability. Amortizing these costs means saving deductions for when your revenue and taxable income is higher.
For sole proprietorships or other pass-through entities, your tax rate is determined by your tax bracket. As your taxable income increases, you might jump into a higher tax bracket and have a higher tax rate.
The higher your tax rate, the more a deduction saves you. If your tax rate is 10%, your conclusion is worth $0.10. But if your tax rate is 22%, the value of that deduction jumps to $0.22.
Towards the end of the amortization period, the deductions will have their highest value if you’re on your desired growth trajectory.
How much you can deduct
The calculation for deducting start-up costs is pretty simple.
In your first year in operation, you can deduct $5,000 minus any over $50,000. The rest is amortized over 180 months (which is 15 years).
Let’s say you have $52,000 in start-up costs. In year one, you can deduct $3,000 ($5,000 minus the $2,000 over $50,000). That leaves $49,000, which is amortized over 180 months. This means you subtract $272 monthly in business ($49,000 divided by 180 months). That’s over $3,000 in deductions every year.
DO set reminders for due dates.
Late fees and penalties are a silent killer of your bottom line.
With taxes, there are often two penalties: one for a failure to file and another for a failure to pay.
On the federal level, the failure to file a penalty is 5%, while the failure to pay a fine is 0.5%. This means you should always file even if you can’t pay, as you’ll avoid the higher penalty.
These penalties don’t stack; if you neither file nor pay, the fine is still 5%. These penalties accumulate monthly and top out at an additional 25% of your tax bill.
The 25% max penalty is just the starting point. Interest also accumulates on any unpaid tax liabilities and unpaid fines.
There’s a penalty for inaccurate filing, as well. Rushing through the filing process and missing a box or forgetting to include something results in a 20% penalty for the amounts owed.
The takeaway: don’t set reminders for just the due dates; set reminders for when you should start the process.
Not just income tax forms
Penalties and late fees aren’t just for income taxes.
These days, many businesses are turning to contractors for help with projects. If you pay a contractor more than $600 during a tax year, you must file Form 1099-NEC to both the contractor and the IRS. The late fee starts at $50 and can jump to $290.
You must stay up-to-date on employment tax forms if you work with employees. Form 940 (reporting unemployment insurance) has a late filing penalty of 5% of the owed amount. Form W-2 has late fees ranging from $50 to $290, the same as Form 1099.
Putting these due dates in a calendar, setting up reminders, and getting an early start on any tax filing process are small steps that can save you big on unnecessary fees.
Key dates to remember
“Tax day” typically refers to April 15th, when individuals and some businesses file income tax returns. But if your business is a partnership or S corporation, that date moves forward to March 15th.
January 31st is the due date for filing Form W-2 and Form 1099-NEC to the contractor and the IRS.
As a new business, you might not need to file and pay quarterly estimated taxes. Estimated taxes have companies paying taxes based on an estimated amount four times throughout the year as opposed to one lump sum. These are due April 15th, June 15th, September 15th, and January 15th of the following year.
Most state income tax returns are the same as the federal tax returns. Prepare to file twice before the March 15th or April 15th deadlines.
Extensions are due the same day as the filing deadline. Successfully filing an extension grants you six additional months to pay, pushing your deadline to September 15th or October 15th.
Every deadline is pushed to the next business day if it falls on a weekend or holiday.
DON’T let your recordkeeping slip.
Your recordkeeping is incredibly valuable. Financial reporting holds vital information about how efficiently your business is operating. Regularly updating and reviewing your reports helps you uncover revenue and spending trends so you can confidently make changes.
But it’s not just about tracking performance. The better your recordkeeping, the easier your tax filing process.
How your recordkeeping helps
Let’s get some terminology out of the way. Your bookkeeping records business transactions and generates financial statements like an income statement and balance sheet.
As you start to organize your expenses, you’ll understand what’s deductible and how deductible it is. This helps with financial planning. You’ll begin to plan purchases based on how it affects your tax liability and actively minimize your tax bill.
Most importantly, much of the information on an income statement can be put directly into tax forms. No more tallying up expenses and estimating amounts. You can confidently enter exact numbers, avoid costly mistakes, and seriously reduce the time to file.
How to stay on top of recordkeeping
Most businesses use bookkeeping software (think Xero, QuickBooks, or Wave). Others may choose to work with a professional to ensure accuracy and keep their time free for growing their business.
The classic spreadsheet works for some and you can find free templates to get started.
When choosing a bookkeeping solution, the best option is the one you’ll most confidently and frequently use. Try out free trials to get a taste of what the workload feels like.
The simpler your transaction history, the easier your bookkeeping is going to be. You can start with a basic solution, but pay attention to how much time you’re spending on bookkeeping tasks. As your business grows, your bookkeeping becomes more complicated, and the need for a more sophisticated solution increases.
Setting up a regular cadence
You should set up a regular cadence to either complete your bookkeeping or review your financial reporting with your bookkeeper.
Think of doing your bookkeeping like produce: fresh is best. Doing it as soon as you can means you’ll remember the details. You’re also most likely to still have that receipt kicking around so you can document any purchases.
Of course, business owners juggle many tasks and bookkeeping can slip. It’s worthwhile to set a reminder to complete it weekly or monthly depending on your capacity.
If you’re working with a professional bookkeeper, it’s worthwhile to set up monthly reviews at the start of your engagement. Your bookkeeper will need to learn the specifics of your business to confirm they’re completing their work accurately.
Remember that the earlier you set up good practices, the easier it is to keep up with them. Falling into a pattern of putting off your bookkeeping doesn’t save you from stress, it only prolongs it.
The Importance of Tax Compliance for eCommerce
Compliance with tax regulations is not just about avoiding penalties; it's about building a sustainable and reputable business. As an eCommerce entrepreneur, understanding the nuances of tax laws can be a competitive advantage. It ensures that you're not overpaying on taxes, and it also safeguards your business from potential legal issues. Moreover, being tax compliant can enhance your brand's reputation, as customers and partners will view your business as responsible and trustworthy.
The Role of Tax Consultants for eCommerce
While it's essential to have a basic understanding of taxes, it's equally crucial to recognize when to seek expert advice. Tax consultants or CPAs who specialize in eCommerce can provide insights tailored to your business model. They can help identify specific deductions, guide you through international tax complexities, and ensure that you're maximizing your profit while staying compliant.
International Sales and Taxes
Selling internationally opens up a vast market for eCommerce businesses. However, it also introduces a new layer of complexity in terms of taxes. Different countries have varying tax regulations, and understanding these can be daunting. It's essential to be aware of customs duties, VAT, GST, and other taxes that might apply when selling to customers outside your home country. Using tools or platforms that automatically calculate these taxes based on the customer's location can be a lifesaver.
The Impact of Tax Incentives
Governments often offer tax incentives to boost certain sectors or encourage specific business activities. For eCommerce entrepreneurs, these incentives can come in the form of reduced tax rates, credits, or even grants. Staying informed about these opportunities can significantly reduce your tax bill and provide additional funds to reinvest in your business.
The Future of eCommerce Taxation
As the eCommerce industry continues to grow, it's inevitable that tax regulations will evolve. Governments are continuously looking for ways to ensure that online businesses pay their fair share. Staying updated on these changes and being proactive in adjusting your tax strategies will be crucial for long-term success.
Summary
Navigating the tax landscape is crucial for the success of any eCommerce business. Recognizing the significance of federal, state, and local tax obligations from the outset is essential. Leveraging expert advice and specialized tools can simplify the challenges of understanding sales tax nexus, capitalizing on start-up deductions, and emphasizing the importance of distinct personal and business finances. Additionally, the benefits of tax compliance, the expertise of tax consultants, the nuances of international sales, the advantages of tax incentives, and the dynamic nature of eCommerce taxation are vital components that can optimize financial efficiency and foster sustainable business growth.
Frequently Asked Questions
What are an eCommerce business’s tax obligations?
eCommerce businesses typically have to pay income taxes, employment taxes, and sales taxes. Sales taxes are due in each state where the business has a sales tax nexus. Depending on the goods you sell, you may be responsible for excise taxes.
What is a sales tax nexus?
A sales tax nexus comes into effect when an online seller has a physical presence or high enough sales in a state. The thresholds and tax amounts vary by state.
What are start-up deductions?
Start-up deductions are deductible expenses that can be amortized (spread out) over 15 years. This lets you save the deductions for when your revenue and tax bill are likely higher. Examples of eligible costs include product research, formation costs, and consulting fees.
What are the usual tax due dates?
Income taxes are typically due on either March 15th or April 15th depending on your business structure. Estimated quarterly taxes are due on April 15th, June 15th, September 15th, and January 15th of the following year. It’s worth marking January 31st, February 28th, and March 31st as the due date for select informational returns.
How does bookkeeping help with taxes?
Your bookkeeping contains all the information you’d need to fill out an income tax return. Beyond that, it helps with tax planning and is crucial to back up your work in the case of an audit.
How does a business bank account help with taxes?
Separating your personal and business finances makes it easy to identify what is and isn’t a business transaction. In some cases, it provides liability protection which keeps your personal assets protected if your business faces legal action.
How can I determine if I have a sales tax nexus in a particular state?
You'll have a sales tax nexus in a state if you have a physical presence or if you surpass a certain sales threshold, which varies by state. It's essential to check each state's regulations.
What are the benefits of hiring a tax consultant for my eCommerce business?
A tax consultant can provide tailored advice, help identify specific deductions, guide you through complex tax scenarios, and ensure you're compliant with all regulations.
How do I handle taxes for international sales?
Each country has its tax regulations. It's crucial to be aware of customs duties, VAT, GST, and other applicable taxes. Using tools or platforms that calculate these taxes based on the customer's location can simplify the process.
Are there tax incentives available for eCommerce businesses?
Yes, governments often offer tax incentives to boost certain sectors. These can come in the form of reduced tax rates, credits, or grants. It's essential to stay informed about these opportunities.
How can I stay updated on changes in eCommerce tax regulations?
Regularly consulting with a tax professional, subscribing to tax news updates, and being part of eCommerce communities can help you stay informed about any changes.
