Dropshipping tax can be very tricky, especially for new business owners. Finding the right product, the right distributor, and the right marketing strategy is just the start of your business launch. You also have to ensure you’re complying with dropshipping tax regulations, and paying the correct sales tax on your orders. In this article, we’ll take a look at the top three dropshipping strategies for small businesses.
What Are the Best Dropshipping Tax Strategies?
One of the things that makes dropshipping unique from a tax perspective is that it allows you to sell products without having to carry any inventory. This means that you don’t have to worry about paying taxes on inventory that you haven’t sold yet.
Instead, you only pay taxes on the products that you’ve already sold. This can be a big advantage for businesses that are just starting out, as it can help to keep your startup costs low.
In addition, dropshipping also allows you to sell products in multiple states without having to set up an office location in each state. This can save you a lot of time and money when it comes to complying with tax laws.
You also don’t have to pay for storage or shipping, which can further reduce your tax liability. In addition, you can use dropshipping to sell products in multiple jurisdictions and potentially without having to pay taxes in each jurisdiction. However, it’s important to note that you may still have to pay taxes on the profits from your dropshipping business.
The Top-3 Tax Strategies for Dropshipping Businesses
We’ll take a closer look at the three main tax strategies that can help you lower your tax burden for your dropshipping business. These include nexus management, taking advantage of section 179 and bonus depreciation, and using your personal deductions.
When starting a dropshipping business, you want to minimize the number of taxable connections (i.e., nexus) created by your company. A nexus is the minimum amount of contact you need with a state for that particular state to impose tax on your business. Each state has their own rules for what constitutes the creation of a nexus.
A physical presence in a state (such a retail store, office, or warehouse) will generally always create a nexus. If you don’t have a physical presence, most states consider nexus to be created when you have had a certain number of transactions or have generated a certain amountof revenue from sources within the state.
By minimizing the number of nexus created by your company, you will simplify your state and local state (SALT) obligations.
Section 179 and Bonus Depreciation
Dropshipping companies do not hold inventory or need delivery vehicles, since the manufacturer ships the products directly to your customers.
Since the business is very lean, you won’t need much equipment. Many dropshipping businesses are run with nothing more than a company, cellphone, and internet connection.
Though the fixed assets are relatively small purchases in a dropshipping relative to the potential revenue, it’s still important to take advantage of the potential write-offs. Fixed assets such as computer equipment and office furniture are usually depreciated over several years.
Small businesses can take advantage of section 179 or bonus depreciation. Section 179 allows the full amount of most fixed asset purchases to be expensed in the year of purchase.
Higher allowable expenses will lower your taxable income and subsequent tax bill. Business expenses are allowed when they are ordinary and necessary for the operation of the business.
Activate Personal Deductions
Since dropshipping operations don’t require business owners to be physically present with their products, most dropshipping companies operate in remote-work environments. Remote work leaves the door open for several potential deductions for personal expenses.
You can deduct your business vehicle mileage by deducting the business portion of your actual expenses or using the standard mileage rate, which changes yearly. To deduct your vehicle expenses, you need to log your miles. Business miles can include driving to an office supply store to pick up supplies or driving to the airport to attend a business conference.
Working from home also allows you to deduct home office expenses. The business use of home deduction is calculated by determining the percentage of your home that is used for business, usually in the form of square footage. Your home expenses such as mortgage interest, real estate taxes, insurance, and utilities are multiplied by the business use percentage.
You should also track expenses like travel, internet, cellphone, and accounting fees. Also, record any expenses incurred from employees and independent contractors if you hire other people to assist you. Consult a tax professional if you’re unsure whether an expense is deductible.
More Important Tax Considerations for Dropshippers
In years past, you risked running into an IRS inquiry if you claimed the home office discount. However, at-home work is much more common than it was in the past
Nowadays, the home office discount doesn’t count for as much of a red flag. However, you should only take a reasonable home office discount to minimize your audit risk.
Keep Accurate and Organized Records
When running any business, it’s important to keep meticulous receipts and records of your income and expenses. Keeping five years of records is ideal, but you should keep at least three years. You’ll need documentation as proof in the event of an IRS audit.
Get Professional Tax Help
Dropshipping gets complicated with state and local taxes. You can waste hours of your time learning local tax laws, or leave it to the professionals. A professional tax advisor will ensure your business complies with all applicable tax rules.
Strategies for Dropshipping Tax: Final Thoughts
Dropshipping businesses boast low overhead expenses and potentially high profits. Plus, you can launch your business with minimal upfront investment.
Despite the simple business model, don’t overlook compliance. You must adhere to all state and local regulations regarding interstate commerce.
Talk to a Tax Pro
Tax Hack specializes in taxes and accounting services for today’s high-tech small business. Our experienced tax team has extensive expertise in eCommerce, dropshipping taxes, and more. Click here to sign up for a one-on-one strategy session with a tax hack pro now, and get answers to your toughest tax questions. .