Guest Post by Jeremiah Kovacs of MuseMinded
As an entrepreneur, you are in the driver’s seat of your own wealth creation vehicle.
To succeed as an Amazon FBA seller, there's a range of activities you need to execute well – such as product sourcing, listing optimization, inventory management, and taxes. While taxes are often the last thing that entrepreneurs want to deal with, it’s important to do them properly, as the potential downsides are significant.
In this detailed guide, we take a closer look at the two main types of tax that FBA sellers in the United States are almost always responsible for paying: sales tax and income tax.
“States and localities use sales tax to pay for budget items like schools, roads, and public safety. Sales tax is a “consumption tax” because it’s only charged when a buyer buys goods or services.” – TaxJar
People often refer to sales tax as a “pass-through tax” because merchants are required to collect it, but they don’t get to keep any of it. At the time of writing, 46 states have sales tax laws in place.
While sales tax is governed at the state level, each jurisdiction is allowed to set its own tax laws, as long as it fits within the framework of the US Constitution. Most states also allow local communities and counties to charge their own taxes, which are supplementary to state levies.
As you can probably imagine, tax law in the United States can get quite complex due to the fragmented nature of the market:
• At the federal level, income tax is collected by the IRS.
• At the state level, sales tax (and other taxes such as the Marketplace Facilitator Tax in Washington and some other states) are collected by state authorities.
• At the local/county level, other levies are often charged in addition to these fees.
Nexus: A Connection or Link to the State
To determine where you have sales tax exposure, it’s important to understand the concept of nexus. In the context of sales tax, nexus refers to a seller or business entity having a connection or tie to the state. If you have nexus in a state, then you are technically required to register for sales tax in that state.
Before e-commerce was a prominent part of the retail landscape, determining where you had nexus was a relatively straightforward task – if you had employees, owners, or physical property in a state, then you would need to register for sales tax there. This was known as hard nexus.
However, online selling (Amazon in particular) has opened up the playing field and enabled local businesses to reach shoppers throughout the US and beyond. This created a sales tax dilemma – where do you have nexus?
“For Amazon sellers that use fulfillment by Amazon or a third-party logistics company, you may have staged inventory in a lot of states. For the typical FBA seller, you are going to have 20+ states that you...have to deal with sales tax in.” – Project Life Mastery
Otherwise known as economic nexus, this presents an interesting challenge for sellers. When you send inventory to FBA, your stock is distributed to Amazon warehouses throughout the US to ensure that it is as close to potential customers as possible. As a result, most sellers are legally obliged to register for sales tax in a wide range of states.
For smaller merchants, this can present a significant challenge – the cost of complying often outweighs the potential penalties for not paying, especially in smaller states. To add another layer of complexity, sales tax laws are in a constant state of flux, with recent supreme court rulings giving states a much wider scope to define what constitutes nexus.
There are three common ways that sellers tend to deal with this dilemma:
1. Do nothing. Register in your home state, and adopt a “wait and see” approach for the remaining states. By holding off, the law might change in your favor; however, it could result in penalties and fines for non-compliance if you are caught.
2. Play it safe. If you can’t sleep at night knowing that tax authorities might decide to pursue you, then it can be a good idea to consider registering everywhere that you have nexus. This is an expensive course of action, which significantly increases the ongoing compliance burden in your business.
3. Stair-step approach. Register in your home state, and keep an eye on how much sales tax you owe in other states. Once your total liability reaches a certain threshold (such as $1,000), go ahead and register in that state. This method is the most common way that sellers manage their sales tax responsibilities.
Destination vs. Origin Based States
State tax authorities have the option to apply sales taxes based on the origin or destination of sales, with most states preferring destination-based. This means that some states charge sales tax based on where your business is located (origin) and others charge sales tax based on where the product is being sent (destination). Each state has different rules on how they handle out-of-state selling.
Here are a few basic points to keep in mind as a general guideline:
• Sales within your state should be taxed if your state charges sales tax. The final rate depends on any local taxes.
• If you and the buyer are both in destination-based states, the tax rate is determined by the buyer’s shipping address.
• Sales from a destination-based state into an origin-based state don’t attract sales tax unless you have nexus in the origin-based state (e.g., inventory in FBA).
• If you sell from an origin-based state, customers pay the tax rate that applies to your state, even if their state operates on a destination basis.
The complexity and importance of getting sales tax right get larger as your business grows. When you are a small player, tax authorities have a much smaller incentive to pursue you. With less stock being held in a smaller number of states, you are also less likely to incur as much nexus.
It is also important to note that some states have a sales threshold where you don’t need to register for sales tax until you do a certain amount of business with clients in their state. For example, Wyoming doesn’t consider you to have economic nexus until you make 200 sales or $100,000 worth of transactions. Check out this comprehensive resource to find out about the sales tax thresholds for each state.
If you require expert guidance based on your specific circumstances, we recommend speaking with a financial expert who specializes in e-commerce businesses.
Tools and Tips for Making Sales Tax Compliance Easy
TaxJar is a leading tool that many Amazon sellers use for managing their sales tax responsibilities. It is easy to set up, integrates with Seller Central and cloud accounting systems, and simplifies the process of calculating, filing, and paying sales tax returns. Other popular alternatives are Taxify and Avalara.
Some states offer sales tax discounts for specific situations where you voluntarily submit and pay your tax returns on time or before they are due.
To simplify the process of collecting sales taxes, Amazon can do it on your behalf. To cover the cost of credit card transactions and processing fees, Amazon charges 2.9% of all sales tax collected for providing the service.
If you want to take a DIY approach to sales tax collection and payment, check out MuseMinded's crash course for more tips and tricks, and if this isn’t something that you want to spend time doing, we'll look after it for you.
Income tax laws in the United States can get very complex and detailed. They are constantly subject to change, so it’s best to work with a specialist tax advisor or CPA that understands your specific requirements. With this in mind, here’s a high-level overview of what you need to know.
Who Is Responsible for Paying Income Tax?
In short, if you make money from selling on Amazon, you are required to pay tax on your profits. If you are a U.S. taxpayer, you will need to file a 1099-K form and send your tax payments to the IRS. If you are a non-U.S. taxpayer, you will need to file a W-8BEN form to become exempt from local tax reporting requirements.
Most sellers trade as sole proprietors, or through an LLC (limited liability company), which makes things much simpler. Larger merchants will sometimes register as corporations, which can add another layer of complexity to calculating and paying taxes. However, there are benefits of running a corporation if you wish to gain strong legal protection over your assets.
What Are the Best Legal Entities for Selling on Amazon?
Here’s an overview of the most common business structures:
Sole proprietorship: Essentially, this is another name for trading as an individual. You’re automatically considered to be a sole proprietor if you do business activities, but don’t register your business. Assets and liabilities are not separated from the owner’s personal finances, and therefore, there is a potentially unlimited downside if things go wrong. Sellers often test the waters as sole proprietors, then register a formal business entity once they have proven their concept to be worthwhile of pursuing.
Partnership: This is the simplest structure for two or more people to own a business together. There are two common types of partnership: limited partnership and limited liability partnership. Profits and losses are passed through to the owners’ personal tax returns. This is not a very common type of legal structure for Amazon businesses.
Limited liability company (LLC): An LLC allows you to take advantage of the benefits of both partnerships and corporations. LLCs protect you from personal liability in most instances, and profits/losses can get passed through to your personal income without facing corporate taxes. This often allows sellers to pay a lower tax rate and encounter fewer fees than they would by owning a corporation. It’s important to note that if you run your business through an LLC, you are required to pay self-employment taxes as your form of income tax.
C Corporations (C Corps): Legal entities that have a separate life from their owners. Corporations can make a profit, be taxed, and be held legally liable. They offer owners the strongest protection against their personal assets. When it comes to raising capital and securing bank loans, it’s easier to do this through a corporation. However, profits are taxed twice in a C Corp: first when the company makes a profit, and again when dividends are paid to shareholders on their personal tax returns.
S Corporations (S Corps): This is a special type of corporation, which is designed to avoid the double taxation issue that C Corps encounter. S Corps allow profits and some losses to be accounted for directly in the owner’s personal income tax returns without ever being subject to corporate tax rates. Not all states tax S Corps equally. Most states recognize them in the same way the federal government does; however, some states tax S Corps on profits above a specified limit and others don’t recognize this legal structure at all, instead treating them as a C Corp. To be eligible to register as an S Corp, you need to meet certain criteria.
Other corporations: There is a range of other corporations, which aren’t necessarily useful for Amazon sellers. These include benefit corporations, close corporations, and nonprofit corporations.
Most sellers get started by testing their ideas as sole proprietors, then registering as an LLC once they have validated the product or business concept. It’s worth seeking professional guidance if you’re unsure which type of legal entity is most suitable for your requirements.
Estimated Tax and Payment Dates
If your primary source of income is derived from working for a wage or salary, your employer will deduct income taxes on your behalf and pass them on to the IRS. As a business owner, someone who is self-employed, or operates as a corporation, you are required to make estimated tax payments quarterly if you expect to owe more than $1,000 as an individual or $500 as a corporation.
These estimated tax payments are broken down into four quarters. Payment is due on the 15th of the month on or following the end of each period.
|Federal Income Tax Generation Period||Tax Payment Due|
|Jan 1 – Mar 30||April 15|
|Apr 1 – May 31||June 15|
|Jun 1 – Aug 31||September 15|
|Aug 31 – Jan 1||January 15|
It’s important to keep on top of your estimated tax payments and try to be as accurate as possible; insufficient and late payments may attract penalties and fines.
Maximize Your Deductibles
When you claim expenses against taxable income, you pay less tax as a result. In general, if an expense is directly related to earning income and required for you to make that money, then it is often tax-deductible. However, there are some exceptions, such as business attire that is also worn outside of work. Consult your tax advisor for guidance related to your specific circumstances.
Here is a list of items that are commonly offset against Amazon income:
• FBA inventory costs
• Amazon fees
• Amazon software and FBA subscription fees
• Supplier shipping and office supplies
• FBA seller education or FBA business-related courses
• Donations of items
• Home office deduction (deductible percentage of mortgage or rent)
• Health insurance plans (speak with an accountant)
• Retirement plans (speak with an accountant)
• FBA sourcing travel and meals where business-related
Remember to keep all your receipts and invoices from suppliers as proof of your expenses. If you are ever audited, this will serve as evidence that you had a legitimate reason to claim such costs. To keep them all in one place, apps like Shoeboxed and Google Drive are very useful. Some cloud accounting systems such as Xero and QuickBooks Online also have the ability to store copies of your receipts.
Which Forms Do I Need to Fill Out?
When you registered to sell on Amazon, you would have completed a tax information interview and filled out a tax form. If you’re a US-based seller, this would have probably been a 1099-K form. If you reside overseas, it would have most likely been a W-8BEN.
If your gross Amazon income reaches $20,000 or 200 individual transactions in a tax year (as a U.S. taxpayer), you will have automatically received a 1099-K form. If you’re a non-U.S. taxpayer, it’s important to complete and submit the W-8BEN form in order to be exempt from U.S. tax reporting requirements. Amazon explains your requirements in a detailed FAQ section here.
How Do I Gather the Correct Info to Do My Tax Returns Properly?
If you’re a small seller and don’t have many transactions to account for, you might be able to get away with using Amazon’s reports. However, there are many potential pitfalls to be aware of, and you can suffer serious consequences if you get it wrong. Rather than running around like a headless chicken come tax time, why not just automate the workload away?
If you are already using a cloud accounting system, such as Xero or QuickBooks Online, then it’s easy to get your financials in order. A2X is a useful plugin that connects Seller Central to your accounting software and accurately imports all your settlements and transactional information into your set of accounts.
This reduces the amount of manual input required to get an accurate handle on your financials and increases the reliability of your accounts. When it comes time to hand over the books to your accountant, not only will they thank you for it, but it will take them less time and potentially save you money.
If you like the idea of delegating the burden of accounting and taxes onto someone else, it’s worth considering working with a niche Amazon accounting company, such as MuseMinded.
By combining the best automation tools for Amazon sellers we have defined the most valuable services that merchants need and tailored our entire business model around providing exceptional accounting services to Amazon sellers.
Tax law is a complex and ever-changing field, where the rules can vary greatly depending on your specific circumstances. The cost of getting it wrong is quite significant, so it’s important to work with accountants that understand your legal obligations so they can work in your best interests
With this in mind, it’s also important to remember that taxes only matter if you make money. We often see people refrain from taking action until they understand the entire picture. In the early days of running your business, there are so many things that need to be done. You should be focusing on making money first, then once you have a stable base of income, you can get serious about managing your tax liabilities.
To learn more about MuseMinded, and how we are helping Amazon sellers in the United States to simplify their accounting needs, check out www.museminded.com.
Disclaimer: This information is provided for informational purposes only. Tax laws apply differently depending on the specifics of your situation. If you are unsure about how to proceed, seek professional advice.