Do you know what your sales tax obligations are? Here’s a breakdown of how much tax you need to pay when Dropshipping – and how to do it.
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You don’t have to tell me already how much you hate taxes.
A lot of us do.
But whether you hate them or not, Benjamin Franklin couldn’t have said it any better: “There are only two things certain in life: DEATH, and TAXES.”
Luckily though, meeting your tax obligations as a dropshipper is surprisingly simple.
I want to show you how. That’s why in this post, I’ll be covering what your tax obligations are when using Chinese based Aliexpress dropshippers. We’ll also take a look at what the new supreme court ruling means for you, plus an easy way to get Shopify to automatically collect tax for you.
Before we move on, it’d be worth mentioning that we are not CPAs, accountants or lawyers. None of this is official legal advice, and as always, we recommend you seek the advice of an accountant and not rely on the advice we offer.
Now, a quick breakdown on two types of tax you need to know: Income tax and sales tax.
What tax do I need to pay?
When Dropshipping, there are two types of tax you need to pay:
- Income tax
- Sales tax
As a business owner, you’re required to pay both taxes. Let’s start with explaining the easiest first: Income tax.
NOTE: Most of the advice will be aimed towards your tax obligations when selling to customers in the U.S. In general, a large chunk of most dropshippers sales comes from the US, so it’d make sense to cover such a broad topic from a neutral standpoint.
What is income tax?
Income tax is when you pay taxes on the profit that your store makes in a year. That profit is basically the “income” of your business.
It’s like when you have a job: You pay income tax on your wages. Your stores profit is basically the “wages” you’ll be paying income tax on.
Of course, if you don’t make a profit you don’t pay any income tax. In fact, you can often claim your losses as a tax credit. But in all, the most important question here is: WHERE do I pay income tax to?
The answer is the country you live in. For example: You pay income tax to your local government. So, if you live in Australia, you will always pay your income tax to the Australian government. It doesn’t matter if your customers are based in the US: you do not pay income tax to the US government, you would pay it to the Australian government.
There is the rare case, like in the US, where you have to pay income tax to both the federal government and your local state. However, this is most likely irrelevant to you if you live outside the US, as most countries don’t have states.
Luckily, income tax isn’t much of a burden to carry and is pretty straightforward IF you know how it works. But now, the trickier issue: Sales tax.
What is Sales tax?
Sales tax is when a governing body imposes tax on goods or services sold within their jurisdiction. TRANSLATION: Paying taxes on the goods or services you sell in a state.
Each state in the US manages their own sales tax e.g. tax rates and (to some extent) their own tax rules. So, instead of the federal government imposing tax, the state itself carries this responsibility in its own hands.
For example, each state has its own tax rates. Some high, like Louisiana (9.98%). Some significantly lower, like Alaska (1.69%). Others: none! like: Delaware, Montana, Oregon and New Hampshire. These states are what we call “tax havens”, because you are not required have to collect or pay sales tax to any of them. While it would be a dream to have EVERY state be a tax haven, the majority of states aren’t. And you will most likely be required to pay sales tax.
In the past, the law required you to have a nexus in a state before you were required to pay sales tax in that state. Nexus is a legal term for when you have a physical presence big enough in a state that you are required to collect and pay sales tax.
To better explain nexus, let’s use an example. If you lived in Arizona, you’d have a very large physical presence, so would have nexus in it. That means if a customer (who also lives in Arizona) comes to your Dropshipping store and purchases a mug from you, you would be required to collect and pay sales tax on that order.
The sales tax rate in Arizona is 5.6%, so this is how much sales tax you would need to collect and pay to the Arizona state.
Now let’s imagine this time round, your customer was from Texas. Because you didn’t live there (or have any physical presence in Texas), this means that you didn’t have any nexus in Texas. That meant that you were not required to collect sales tax on that order and pay it to the Texas state.
If you haven’t figured out already, this also meant that if you lived outside the US, you didn’t have to pay any sales tax at all! Since you didn’t live in any state, you’d have no nexus in the first place.
However, this supreme court ruling that put this law in place, Quill Corp v North Dakota (1992), was recently abolished.
And overturned by the new supreme court ruling – South Dakota vs. Wayfar – passed on June 21st, which now requires large out-of-state vendors to have to collect and pay sales tax – regardless of whether they had nexus in a state or not.
This begs the question: Does this mean that YOU now have to collect and pay it even if you don’t have nexus?
The answer is no. To be required to collect and pay it, the following would need to happen:
1) A state needs to pass a law which overrides the baseline nexus law (most states have not passed a bill yet).
2) You will need to be a large vendor (the current baseline is doing $100,000+ sales in a single state, or 200+ transactions in a year).
For most established stores, this means that they will likely only have to start collecting and paying sales tax in a small percentage of states – likely the large ones such as New York City.
BUT, if you are a NEW dropshipper, then you do not need to worry about this until you start making a lot of money and making a lot of sales.
For now, you only need to collect and pay sales tax on orders made in states that you DO have nexus in (which for most people, will only apply to the state that they live in). Luckily, Shopify makes such a tedious job SUPER simple.
Get Shopify to collect sales tax for you
If you own a shopify store, you can have Shopify collect sales tax on each transaction you make. The video below shows you how to easily do this (min 10:03 – 11:02):
Shopify automatically collects the right amount of sales tax on an order. This is handy as in some states the amount of sales tax you’re required to pay varies depending on which city your customer lives.
Prime example: New York. We did two test orders on one of our stores. One delivery address being in New York. The other: Buffalo.
Despite both locations being in the state of New York, the sales tax each order was charged were different:
Nevertheless, the biggest takeaways from today’s post are:
- Just like a job, you are required to pay income tax on the profits of your business. This gets paid to YOUR government (wherever you live), and usually paid annually.
- Online sellers are required to collect and pay sales tax in any state where they have a nexus in. If you’re an out of state vendor with no nexus in a given state, you don’t have to pay or collect any sales tax (so long as you don’t fall under two of the requirements given above)
Hopefully, this post helped to break down your tax obligations in a simpler, easy-to-understand way.
But who wants to end on taxes? Instead, I’d like to leave you with a free gift I think you’ll love.
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- The right way to choose AliExpress suppliers. Picking the right AliExpress dropshipper is crucial to drastically reduce things like refunds. Learn how to pick the right suppliers.
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