If you have an E-Commerce site, there will be many layers of taxes of which you should be aware. Luckily, the U.S. tax code provides many deductions and credits which you can use to offset your gains. Not all taxes discussed below will apply to every site.
1. Federal Income Taxes – If you run your site as a sole proprietor you will fill out Form C on your 1040. If your site is owned by an LLC which you have elected to be taxed at the individual rate, the LLC will do its own tax return and supply you with a K-1 which you will file with your normal 1040. If the LLC has shown a loss, you can deduct this from your other earned income. If your site is run by a Corporation it will have its own tax return.
2. State Income Tax – If your state has an income tax, the K-1 income will be used as it is for the 1040.
3. City Income Tax – Many cities have an income tax which you may also need to pay.
4. Employment Tax – If you have employees, you will need to withhold Social Security and Medicare taxes from their paychecks. Using a payroll service will greatly reduce your burden for figuring and filing this tax at a very reasonable price.
5. Self Employment Tax – If your K-1 shows a profit, and you do the work for the E-Commerce site yourself, you will be responsible for paying both the employer’s and the employee’s portion of the Employment Tax. This is a big burden, currently equal to about 15% of the LLC’s operating income. Sole proprietors have this same burden.
6. Withholding Tax – You need to pay your estimated total tax quarterly. Because you often do not know exactly what your tax will be for the year, the IRS has created a safe harbor if your quarterly payments equal your tax from the previous year.
7. Sales Tax – The sales tax rules for online sales are incredibly complex. There are products and services taxed in some states that are not taxed in others, and location of sales or your inventory is often a deciding factor on collecting sales tax.
Most sites know they must collect the sales tax for sales made in their own state (if their state has a sales tax), or in states where they have a physical presence. However, over the past few years most states have instituted online sales taxes (Often called the “Amazon” tax) using a different name and basing it on accumulated sales within their state. While this seems unfair, and may even fly in the face of the U.S. Supreme Court’s decision in the Quill case, most online retailers are now subject to these taxes.
You need to know what your sales tax liability is before you ship your product or provide your service so you can charge your customer the proper sales tax. Otherwise, if you are audited, you will need to pay the tax and the penalty without having had the chance to bill your customer.
As I said, the online sales tax rules are incredibly complicated. They have sprouted a whole new business niche for companies who will help you decide who to tax and how much to tax, and how to file the tax you collect. Of course these companies will charge you a fee for their services.
Don’t make the mistake of thinking you won’t get caught. Credit card companies routinely report your revenue to the States.
Please feel free to contact me with questions you may have about this blog article. However, your best bet is probably to speak to your accountant to make sure the layers discussed above that apply to you are being properly accounted for.