What is Sales Tax?

Because most products are taxable, you will likely need to account for sales tax (also referred to as sales and use tax in some states). Sales tax is essentially a tax you pay to the government when you sell goods and services. If you plan to sell taxable products, you will need to collect sales tax from your buyers.

For small local businesses, sales tax is often pretty simple as they just need to know the sales tax from which their company operates. However, if you operate in several states (as you do online), you will pay a different tax rate from state to state. 

When it comes to dropshipping, you may wonder who collects the sales tax, the seller or the supplier? 

How Dropshipping Sales Tax Works

When dropshipping, there are three parties involved. The supplier supplies you, the seller, with products that then sell the products to the customer. If you, your supplier, and the customer are located in different states, then you will likely all have different state tax rules.

There are many variables that come into play when determining who will collect the sales tax. We will go over different scenarios to give you a better understanding of dropshipping sales tax.

How To Handle Sales Tax Issues On Your Own

First things first, make your business official by consulting with a professional to determine which licenses and certificates you may need in the state you will be selling from. More than likely, you will need a sales tax permit (also referred to as a seller’s permit). Because you will probably perform your dropshipping business at home, you’d rarely require a local business license. However, it never hurts to double-check your local laws and regulations.

With drop shipping transactions, the point of sale, or where the transaction takes place, is essentially the buyer’s delivery address. Because of this, since you are the “middleman” of this transaction, you may be the one responsible for sales paying sales tax depending on where you and the supplier are located.

More often than not, you are not required to pay sales tax on products purchased from your vendor. You are the retailer would not pay sales tax from the vendor, but collect the sales tax on the sale of the item to the end user. To not pay sales tax on merchandise that is being resold, the vendor will request a resale certificate (also referred to as a resale exemption certificate) will allow you to be exempt from paying sales tax for purchases you intend to resell.

The best method to collect sales tax would be to use an eCommerce platform, such as Shopify, which basically handles sales tax for you. 

Understanding State Laws

Businesses have a legal obligation to pay income tax to the federal government, but there is no federal sales tax in the US. Each state has its own tax percentages and laws. 

Some states that do not have a state sales tax will allow locations within the state to charge local sales tax. So, it is important to always double-check the sales tax for the specific state and city where the item is shipped to.

Adding to the complexity of sales tax laws, each state has different thresholds for reporting and paying sales tax. Many states chose to not burden smaller businesses and only require sales tax obligations if the remote seller ships over 200 transactions or over $100,000 in sales to the residents in their states. Other states require paying sales tax if only one transaction is made in their state. 

Also see: What Are the Penalties for Not Paying Sales Tax?

As previously mentioned, there are two transactions within three parties involved in dropshipping. In addition to collecting sales tax, you yourself may be required to pay sales tax depending on where your seller is located. 

Your supplier may be registered in one of the 45 states with sales tax. To determine the state’s tax rate, you will look at the “ship to” state. 

If your supplier registered to collect sales tax in that state, they will be required to collect on all transactions in that state. The only exception is if they accept a resale certificate instead of collecting tax.

Simply put, the supplier will either collect the state tax for which they are registered or provide a resale certificate for that sale. 

The vendor may be registered in many states (45) with sales tax plus the District of Columbia (D.C.).

TaxJar is a great resource for keeping up with sales tax requirements. 

What is Nexus?

Nexus (or economic nexus) is the relation between a state that requires sellers to register and remit sales tax within that state. Although Nexus typically only applies to businesses that have a physical presence, such as having an office, warehouse, fulfillment center, or employees outside of the state where you are “headquartered.”

The U.S. Supreme Court determined in the case of South Dakota v. Wayfair, that an out-of-state seller could establish nexus through economic activity alone and that physical presence is not required to create nexus. 

Nexus used to make sales tax even more challenging for small business owners with a dropshipping business. Luckily, there have been some changes made for remote sellers. You more than likely will not run into any issues, but it is helpful to know and worth looking into to ensure you’re managing sales tax properly.

As a drop shipper, the main issue you will run into is if your supplier has sales tax nexus. Because the supplier is billing you, even though the products will be shipped to the customer, they will be required to charge you sales tax. If you have a resale certificate, then you will be considered tax-exempt, however, you will need to collect sales tax from your customer.  

So, the best way to avoid paying any sales tax is to ensure you have the proper resale certificate documentation. This document is valid in any state that has sales tax nexus. 

7 Dropshipping Tax Questions Answered

Here are the most commonly asked questions regarding drop shipping sales tax.

Conclusion

Dropshipping is a business that has three parties: the supplier, the seller (you), and the customer. You usually will not be required to pay sales tax to the supplier but will need to collect sales tax from your customers. Each state has different sales tax laws and required permits, so be sure to look at your state’s regulations. Certain e-commerce platforms, such as Shopify, will automatically collect sales tax for you.

Please be sure to consult with an accountant to be sure the dropshipper has the correct permits and is collecting sales tax as required, otherwise, the business may be on the hook to repay the sales taxes due.

However, the exact penalties will depend on your local and state tax jurisdiction, as well as other complicating factors like e-commerce sales. 

Can You Go to Jail for Not Paying Sales Tax?

Individual states and municipalities have written their own sales tax laws regarding penalties for failing to pay and submit a sales tax return. Since there is no federal sales tax in the United States, business owners must ensure that they pay individual state governments and cities their fair share of sales tax. 

The short answer to this question is “yes.” You may be required to serve a prison sentence for “willfully” failing to remit sales taxes on transactions as this is a felony in many states. The next section details the state-by-state penalties for purposely failing to collect sales tax. 

It’s important to note that in order to legally charge sales tax to customers, most states require applying for a sales tax permit in each state where you have a taxable nexus. If you do business in multiple states, you’ll need to register in each of those states. 

The Difference Between Civil and Criminal Penalties

Civil penalties typically focus on repayment with interest and do not include jail or prison time. Criminal penalties, on the other hand, can span the penalty spectrum from fines to imprisonment on the basis of a judge’s leniency and local laws.  

Determining Sales Tax Nexus

One key aspect in determining sales tax responsibility depends on your business’s presence or economic nexus in a particular jurisdiction. For instance, most businesses must have a physical presence such as an office or other substantial presence in a given region in order to assume responsibility for sales tax payments to that jurisdiction. 

Sales Tax Penalties by State

This table provides the most recent sales tax penalties levied by each state. The exact penalty will also be dependent on the particular local tax jurisdiction in which your business resides. This table only shows penalties from the state government. 

How to Waive Sales Tax Penalties

Tax jurisdictions typically do not allow for the waiving of sales tax penalties. If you are involved in a criminal case associated with sales tax collection, then an attorney will offer guidance on navigating the judicial process. 

In some cases, your business may be able to work out a repayment plan with the government’s revenue collection department (usually called the Department of Revenue or Department of Taxation). These negotiations may be able to lessen the monthly payment burden on your business.

It’s no doubt that most people around the world are turning to self-employment businesses. Self-employment can be one of the best ways to earn a living. However, it requires persistence, dedication, and sacrifice to start and run a self-employed venture. Self-employment allows you to be your own boss—you get to decide your working schedule, and more importantly, you get to enjoy valuable tax deductions.

This article walks you through some tax deductions allowable for self-employed individuals. But before that, it’d be a good idea to understand what self-employment is. Read on to get enlightened.

What Is Self-Employment?

Self-employment is the practice of working for oneself rather than for an employer. This means self-employed individuals aren’t under any employers and don’t earn any salaries. They earn money by working for themselves. Examples of self-employed individuals include freelancers, independent contractors, farmers, and sole proprietors. 

What Is A Tax Deduction?

A tax deduction is an amount of money that the national revenue authority allows you to deduct from your total taxable income. This puts you under a lower income tax bracket, reducing the amount of tax you pay to the government. Essentially, a tax deduction is a tax allowance that’s legally accepted to help reduce the tax burden.

Allowable Tax Deductions For Self-Employed

Working as a self-employed allows you to claim a variety of tax write-offs. Some of these incentives include tax deduction allowable on:

1. Cost Of Assets

Cost is the amount of money spent to purchase an asset and any other incidental costs like transport and insurance. The cost of an asset can be charged on its useful period through a process known as depreciation. 

Depreciation is the loss in value of an asset, and it’s treated as an expense to the business. So, depreciation reduces the amount of tax payable. In other words, depreciation is an allowable tax expense. However, to better understand how the different types of assets can affect your taxable income, you need to understand some of the asset write-off rules developed by the government. 

2. Home Office

When you conduct your business from your house, then your home becomes your office. In such a case, you’re entitled to a home office tax deduction. However, to qualify for this deduction, you must regularly and exclusively use your house or part of it for business purposes. 

Some of the eligible expenses for home office deductions include utility costs, a portion of the rent, mortgage interest, repair and maintenance, property taxes, and much more.

3. Private Vehicle

Sometimes, you can use a private vehicle to attend to your business-related concerns. Some of these matters may include delivering products to clients or traveling to attend business meetings. So, if you use your vehicle to attend to business issues, you can take advantage of deductions available for vehicle mileage and other related expenses like wear and tear.

There are two options for vehicle-related tax deductions. The first option is the standard mileage that allows you to make deductions based on the number of miles you’ve traveled using your personal car to address business matters. The second type is the actual option that allows you to claim deductions based on real costs of depreciation, fuel, car maintenance, and other related expenses. 

4. Health Insurance Premiums

Another tax-allowed deduction entitled to self-employed individuals is on health insurance premiums. The revenue authority allows you to deduct the total cost of health insurance premiums for yourself and your dependents like your spouse and children. This amount is deductible from the total taxable income, thus allowing you to pay less tax. 

5. Professional Development

Though there are several ways of promoting one’s skills and knowledge, the most common way is through education. Expanding your knowledge is one of the ways to help you stand out from your competitors. 

So, if you’re a professional and decide to go back to school, you can claim a professional development or a continuous education deduction. However, you must confirm that you’ve used business funds to settle your school fees and other related expenses. 

6. Business Insurance

The future is always uncertain. For that reason, it’s a good idea to protect your business against eventualities like fire and theft. That’s where payment of insurance premiums comes in. Some of the assets you can consider insuring include business vehicles, buildings, and inventories. So, if you’ve insured your business, you can claim your business insurance tax deductions.

7. Retirement Scheme Contributions

One of the best ways a self-employed individual can take care of their future is by establishing an old-age retirement plan. A retirement plan is a practice of setting aside some amount of your business profits and save them in a retirement scheme.

A retirement saving plan ensures you remain financially stable even after retiring or when you won’t be productive enough. Apart from taking care of your old age, contributing to a retirement scheme helps reduce the tax payable to the government. 

Takeaway

Taxation is a complex business concept that keeps changing now and then. Some new taxes can be introduced while others can be abolished at any time. That’s why you must keep updating yourself about tax regulation. But most importantly, you need to understand which deductions are tax allowable and which ones aren’t. This ensures you reduce your tax burden, allowing you the opportunity to maximize your profits.