Taxes can be daunting and overwhelming, but they’re crucial to managing a business. This is especially true for all physical brick-and-mortar stores like boutiques and restaurants. But what about online businesses? Do they have to pay taxes as well?
A few decades ago, tax obligations were exclusively imposed on businesses with a physical presence. This leaves new online business owners in the gray area until the law has finally caught up to the system after 25 years.
In 2018, it was ruled that states have the power to exercise their constitutional rights to impose tax obligations on online retailers. This includes all the transactions made from within and outside the state where eCommerce operates.
Now, online retailers have to monitor and settle their taxes accordingly. If that’s not distressing enough, every state has its own sales tax regulations. For example, the sales tax for online purchases in California is 7.25%, which is 3.25% higher than in New York.
To ensure you’re paying your taxes appropriately, here’s an essential guide to help online sellers as you navigate through the system. This article will teach you everything about tax obligations for online businesses, so read on to learn more.
What Are The Taxes Online Businesses Have To Pay?
There are two types of taxes online businesses have to settle: income tax and sales tax.
Income tax is a type of tax imposed by the government on the income generated by businesses, including eCommerce. By law, individuals and businesses must file their tax returns annually to determine and settle their tax obligations.
Income taxes are one of the government’s sources of revenue. They’re used to provide essential goods for citizens, settle government obligations, and fund public needs such as the construction of highways, bridges, and other infrastructures.
Income taxes depend on the type of business structure. Here’s a quick guide:
For sole proprietors where most online businesses are included, the amount of tax is based on their total annual revenue.
For businesses under partnerships, the amount of tax is based on the individual income of the owners. In other words, the company doesn’t have income taxes to pay.
For limited liability companies (LLCs), the amount of tax is based on the member’s shared profits. An LLC doesn’t have income taxes to pay because it’s treated as a pass-through entity.
For corporations (S- and C-type), the amount of tax is based on the salary of the owners, provided that they’re working for the corporation just like its employees. The corporation, unlike LLCs, have income taxes to pay based on the profits it generates.
Keep in mind that even the smallest online business has income tax obligations as long as it’s registered with the government.
eCommerce Sales Tax
eCommerce sales tax is a type of tax charged to online customers. It functions similarly to how brick-and-mortar shops tax their customers based on the products they purchase during the payment process.
Although it’s popularly known as internet, online, or eCommerce sales tax, such terms are actually misleading. That’s because there’s no such special tax reserved for the sales of online businesses.
The government just updated the taxation laws to impose its jurisdiction over the digital realm. This means doing business no longer requires a brick-and-mortar shop, office, or warehouse. As long as you’re selling products, you need to charge and collect sales tax from your customers.
Do You Have To Charge Sales Tax For Online Sales?
If you’re a responsible online retailer, it’s your duty to tax your customers the right amount and remit the taxes back to the state where you operate.
Here’s a basic rule for online retailers when charging and collecting sales tax:
Your online business has tax nexus as your buyers are from the same state.
Your products are considered taxable in your state.
Such concepts are quite vague, so here’s an in-depth discussion to help you understand them further:
Sales Tax Nexus
Sales tax nexus is a fancy term to say a business has a significant connection to its home state. Suppose you have sales tax nexus in your state. It means your state requires you to include sales tax in your goods and charge the buyers from your state.
Sales tax nexus is automatically mandated in a home state. However, certain activities may establish nexus in other states as well.
Here are the ways to create sales tax nexus in other states:
Having a physical presence (e.g., office or warehouse) in other states
Having an employee, salesperson, or contractor in other states
Storing inventory in other states (with or without personnel or business facilities)
Having someone to advertise your product in other states
Engaging in drop shipping business from someone in other states
Selling products in other states during a special event (e.g., trade shows, exhibits, and other business events)
Exceeding a mandated amount of sales or number of transactions in a particular sale
If your online business engages in one of the following activities above, you have sales tax nexus in those states as well in addition to your home state.
How To File Sales Tax?
Once you’ve determined the states where you have sales tax nexus, it’s time to learn how to stay compliant. Here are the three steps to ensure sales tax compliance:
Register For A Permit
First, register for a sales permit in all the states where you have nexus. To do this, contact the taxing authority of your state, also known as the Department of Revenue. They’ll need your information, about you, your business, and your business activities.
Make sure not to skip this step because some states consider filing sales tax without a permit illegal. This is because they see it as pocketing the people’s money.
Collect And File Your Taxes
Next, start the tax collection online. You can use a tax collection engine to make it a lot easier for you to collect taxes. Then, file your sales tax returns.
The process of filing sales taxes may vary from state to state. Check with your state about the process of filing sales taxes and make sure to do this within the filing period. Otherwise, it’ll result in late or non-filing, which can incur penalties.
Automate Your Processes
Collecting and filing sales taxes manually can be overwhelming and stressful. That said, consider automating the process by using tax management software. This can help you save a lot of time and reduce the risk of errors.
Paying taxes can be overwhelming, but it doesn’t have to be as long as you know the concept and the process behind it. First, check all the states where you have nexus. Then, proceed with the filing—get a permit and start collecting sales taxes.
If your business grows bigger, consider automating the taxation process to simplify the process and reduce further errors. This can help you save time and money in the long run.
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