Dropshipping vs eCommerce: Tax & Accounting Guide

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Ecommerce and dropshipping are two popular ways of selling goods online. While both have similarities, there are also key differences between the two business models that entrepreneurs should be aware of. In this article, we will take a closer look at ecommerce and dropshipping, compare and contrast the two, and discuss the tax and accounting considerations for each.

Dropshipping vs eCommerce: What’s the Difference?

Ecommerce is an umbrella term for selling goods or services online. Typically, the term refers to online retail businesses, but eCommerce businesses come in many different flavors.

A typical ecommerce business might sell products through its own website or online marketplaces like Amazon or Etsy. They may also sell services, such as website design or digital marketing.

Ecommerce businesses typically handle their own inventory, shipping, and customer service, and they may have physical storefronts in addition to their online presence.

Dropshipping, on the other hand, is a form of ecommerce, but it follows a different process. Dropshipping refers to company that sell products from a third-party supplier. Essentially, the dropshipper acts as a middleman between the customer and the supplier.

First, a customer orders from the dropshipper’s website. Then, the dropshipper forward the order to its supplier for fulfillment. Finally, the supplier sends the item to the customer, and the dropshipper makes a commission or profit on the sale.

Most dropshippers never even see the products they sell, so they don’t have to worry about keeping track of inventory or warehousing.

Dropshipping’s main advantages are low operating expenses and minimal risk. These business can operate with as little as one computer, so they are often more flexible and lean than a traditional business. They also require fewer personnel than a fully-staffed eCommerce company.

However, dropshipping also has its downsides. Dropshippers don’t have as much control over their products or suppliers, and they sometimes can’t provide the same level of customer service as a traditional ecommerce business. Customers generally blame whoever sold them an item for any problems, so dropshippers could receive unwarranted complaints due to any delays or errors. Dropshipping companies also have greater difficulties monitoring product availability.

On the other hand, eCommerce businesses have more control over their products and suppliers, but they also have greater overhead costs. A D2C eCommerce business needs to spend on inventory and warehouse space, plus employees to handle shipping and customer service. However, ecommerce businesses also have more opportunities to grow and expand. They can build their own brand, create a loyal customer base, and diversify their product line.

Depending on the business structure, eCommerce businesses typically have greater overhead costs than dropshipping businesses. Traditional eCommerce businesses also need space to store their inventory, and inventory acquisition costs can also add up.

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Infographic credit to Builder.ai

Tax and Accounting for eCommerce and Dropshipping

Dropshipping companies face different tax challenges than their eCommerce counterparts. Here’s what you need to know:

Income Tax

Ecommerce businesses and dropshipping businesses are similar in that they both involve selling products online, but there are some key differences in terms of income tax. Both types of businesses ultimately pay sales tax on their net income.

Dropshippers tend to have very low overhead, so dropshipping taxes typically center around the markup companies charge on their products. They only earn income from the markup they charge on the products they sell, which is subject to income tax unless they have other relevant businesses expenses.

Ecommerce businesses, unlike dropshipping businesses, tend to have a significant amount of deductions beyond just the cost of their products. These deductions can include expenses such as website hosting fees, advertising costs, and credit card processing fees.

Additionally, ecommerce businesses may also be able to deduct the cost of office equipment and supplies, as well as any expenses related to running a physical storefront or warehouse, if they have one. This can also include expenses like utility bills, rent, and insurance. These deductions can be a significant advantage for ecommerce businesses, as they can help to lower the overall income tax burden. However, it’s important to keep accurate records of all expenses and consult with a tax professional to ensure that they are all tax-deductible.

Sales Tax

Sales tax is another area where ecommerce and dropshipping can differ. If a business has a nexus, or physical presence, in a state, they must register, collect, and remit sales tax. Dropshipping can be complicated in this regard, as some states tax the full retail price of the transaction, while other states only require taxing the wholesale price.

The decentralized nature of dropshipping can make it difficult to determine nexus, and dropshippers who facilitate orders to customers located in the same state might be on the hook for sales tax. Some states consider an in-state supplier to qualify as a nexus for that sale. California, New York, Texas, and Florida have particular clauses about this scenario.

Inventory Bookkeeping

In terms of inventory bookkeeping, dropshippers don’t have control over their own inventory, which makes accounting easier. They don’t need to track inventory levels or value, and they can simply record the cost of goods sold when an order is placed. Ecommerce businesses, on the other hand, typically maintain their own inventory and must account for it accordingly. They need to track inventory levels and value, and they may need to use accounting methods such as first in first out (FIFO) or last in first out (LIFO).

Accounting methods

The best accounting method for your business will depend on a number of factors, particularly whether you keep inventory. Drop-shipping businesses should consider a cash-based system because they don’t maintain their own inventories.

Ecommerce companies with lots of resources tied up in inventory may be better off with a double-entry or accrual method. Typically, larger companies with significant A/R and A/P balances should consider accrual. More streamlined, smaller companies with primarily cash operations should lean towards cash.

Final Thoughts

eCommerce and dropshipping both share a common goal, making money online. However, they go about their business in very different ways.

Ecommerce businesses typically handle inventory, shipping, and customer service. Conversely, dropshippers act as a middleman between the customer and the supplier. Both business models have pros and cons, so entrepreneurs should carefully consider their goals before deciding which model they prefer.

Tax and accounting considerations for ecommerce and dropshipping also differ, and you should know which regulations apply to your business. Consider working with a professional tax advisor to ensure your business complies with all applicable tax rules.

At Tax Hack Accounting, we specialize in tax and accounting service for eCommerce and other cutting-edge businesses. Our tax pros can assist you with your toughest tax challenges and help you save big on your annual tax bill. Connect with us now to schedule a one-on-one strategy session to see how we can help your business grow and succeed.

 

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