Dropshipping taxes apply to a very specific type of business arrangement. Dropshippers don’t hold their own inventory. Instead, they take orders from customers and purchase the goods from a third party. The third party mails the good directly to the buyer. This can be an outstanding way to start a business without a ton of money. But, many dropshippers worry about taxes related to this business strategy.
We understand this concern, so we’ll use this article to explain dropshipping taxes. Specifically, we’ll cover the following topics:
- Do You Pay Tax on Dropshipping?
- How Does Sales Tax Work for Dropshipping?
- Who Pays Dropshipping Taxes?
- Should I Charge Tax on Shopify?
- What If I’m a Dropshipper Who Sells Internationally?
- Is Dropshipping Dead in 2021?
- Takeaways: Dropshipping Taxes
Do You Pay Tax on Dropshipping?
Short answer: yes, you pay tax on dropshipping. However, the term “tax” is a general term, and dropshippers need to understand several different types of taxes. Of note, dropshippers will be expected to pay income tax, sales tax, and – potentially – excise tax.
Income tax is what the government assesses based on your business’s profits. All US dropshippers will need to pay federal income tax on their profits. And, most states assess income tax, as well. As a small business owner, you won’t have an employer to withhold these taxes from your paycheck. Instead, you’ll need to make estimated income tax payments every quarter.
Of note, this tax comes from a dropshipper’s profit. If you don’t make a profit in a given year, you will not owe income tax from your dropshipping business.
Sales tax is a consumption tax that consumers need to pay for the purchase of certain goods and services. In general, this tax is imposed at the state level. But, some cities and other municipalities impose sales taxes, too. And, this tax consists of a percentage of the total sale. For example, a consumer may need to pay 8% sales tax on a $100 purchase, meaning the entire purchase would total $108.
Consumers typically pay sales tax at the point of sale. As a result, consumers pay sales tax, but dropshippers collect, file, and submit these tax payments to the government. This requires dropshippers to keep accurate records of all sales – and the associated sales taxes.
Governments impose additional taxes on some industries considered dangerous to the general population. These are known as excise taxes or “sin” taxes. For instance, New York City and New York State both impose an excise tax on the sale of cigarettes.
How Does Sales Tax Work for Dropshipping?
As stated, dropshippers will likely need to deal with sales taxes. When they make a sale, the consumers pay the sales tax directly to the dropshippers. However, dropshippers need to then remit this payment to the government. The specific sales tax rate will depend on the state, and some states have no sales tax.
What is Nexus?
In the United States, dropshippers must collect sales tax when they have a sales tax nexus in the buyer’s destination state. But, what’s a nexus? Generally speaking, states define a nexus as a physical presence. For a dropshipper, your state likely considers your presence in that state as a nexus.
For instance, say you are a dropshipper in New York. If someone buys a product to be shipped to a New York address, you’ll need to collect and remit sales tax. But, if you ship a good to a Texas address, you will not, as you don’t have a nexus in Texas.
How Do I Become Exempt from Sales Tax?
Dropshippers should also familiarize themselves with exemption certificates. These certificates allow dropshippers to make tax-free purchases that would typically be subject to sales tax. Each state differs on the procedures, but the process is fairly standard. A purchaser fills out an exemption certificate and provides it to the seller. The seller then keeps the exemption certificate and can sell goods to the purchaser without charging sales tax.
Generally speaking, dropshippers can qualify for an exemption certificate so long as they intend to resell the goods. Additionally, tax exemption may be awarded based on your industry or business structure. But, you’ll need to confirm the specific rules of your state.
Who Pays Dropshipping Taxes?
Once again, it depends on the type of tax. Income taxes are assessed based on a business’s profits, and the dropshipper is solely responsible for paying these. You will need to pay estimates of your annual income tax on a quarterly basis. Consumers, on the other hand, pay sales taxes when required. But, dropshippers collect these sales taxes and remit them to the government.
Should I Charge Tax on Shopify?
Fortunately, Shopify can automatically add and collect sales tax based on the customer’s location. If you select this option, Shopify will calculate and charge the sales tax relevant to each purchase. This helps significantly, as sales taxes can go down to the city level.
Of note, if you do not activate this Shopify feature, sales tax will be assumed to be added manually by the dropshipper. This is an extremely time-consuming, detail-oriented process. Bottom line, it’s far easier to let Shopify handle sales taxes for you as a dropshipper.
Dropshipping on Shopify
Shopify serves as a convenient, ready-to-go dropshipping platform. Plus, it’s compatible with multiple dropshipping providers, including Oberlo, AliExpress, and Spocket, among others. However, this convenience must be balanced against two main tradeoffs. First, you must pay for Shopify access. While not a major expense, this can cut into a new business’s bottom line. Second, Shopify offers limited providers, reducing dropshipper flexibility.
What If I’m a Dropshipper Who Sells Internationally?
Unfortunately, many foreign governments use different tax terms than the United States. This can make things very complicated for dropshippers. But, the general structure tends to be similar. International dropshippers may encounter the following tax-related terms:
- Tariffs: These are taxes imposed on goods imported from another country. Importers may indirectly pass the tax on to the final consumer.
- Duties: These are taxes imposed on the consumer for imported goods. And, some governments can impose these consumption taxes for local goods, as well.
- VAT: This stands for value-added tax. It is an indirect tax on the consumption of goods. This tax is commonly seen outside of the United States.
- GST: This stands for goods and services tax, and it is a type of VAT. It is assessed on most goods and services sold in a country for domestic consumption.
Is Dropshipping Dead in 2021?
Despite what some online critics would have you believe, dropshipping is absolutely not dead. It remains an extremely viable business option and thriving industry in 2021. And, unlike many new businesses, it doesn’t require a significant amount of start-up capital. This makes dropshipping a great option for hard-working, entrepreneurial individuals without a ton of seed money.
Takeaways: Dropshipping Taxes
If you’re looking for a viable online business opportunity, dropshipping may be for you. However, as with all businesses, you’ll need to pay some taxes as a dropshipper. These will include income tax, sales tax, and, for some sellers, excise tax.
However, these taxes shouldn’t overwhelm you. Simply put, taxes shouldn’t dissuade you from beginning a dropshipping business. At Tax Hack, we live and breathe taxes for dropshippers, so contact us to set up a tax planning strategy session!