Navigating Dropshipping Taxes for U.S. Businesses

U.S.-based businesses can use dropshipping to fulfill customer orders without actually having to keep the products in stock. It’s a great way to save space, time, and money for retail businesses. Dropshipping is on the rise — the global market value is projected to reach $1670.1 billion by 2031.  

Interested in growing or starting your own dropshipping business? Here’s what you should know about dropshipping taxes for U.S.-based businesses.

What Is Dropshipping?

Dropshipping is a way of selling goods through a store or website without storing inventory in your own warehouse.

Dropshipping involves two transactions: a transaction between the dropshipping owner and the customer and one between the supplier and the customer. There are three steps to the dropshipping process: 

  1. The dropshipping owner receives a customer’s order.
  2. The dropshipper purchases the order’s items from a third-party supplier.
  3. The third-party supplier ships the products to the dropshipper’s customer.

Do You Have To Pay Taxes on Dropshipping?

You’ll pay taxes on dropshipping based on your sales tax nexus. A sales tax nexus is the presence of a business within a state.

A dropshipping business based in the U.S. has a nexus for income tax when it:

  • Derives income from sources within the state.
  • Has capital assets or property within a state.
  • Has employees there engaging in work 
  • Leases or owns property there.
  • Dropshipping businesses based in the U.S. may have a sales tax nexus in its state of operation because it has:

  • A physical location in the state. 
  • Employees who regularly solicit business there, such as salespeople. 
  • Property, including intangible property, within the state. 
  • Residents working in the state. 
  • There are a number of platforms available to help streamline your dropshipping business. The most popular dropshipping platforms you can use for your dropshipping business are:

  • Amazon
  • Etsy
  • Inventory Source 
  • Magento
  • Shopify
  • Squarespace
  • Weebly
  • WooCommerce
  • What Taxes Do I Need To Pay for Dropshipping?

    Dropshipping businesses are unique in that both tax nexus types can cause dropshipping owners to pay taxes. As a result, there are two taxes you’ll pay for dropshipping: income tax and sales tax. 

    Income Tax 

    The first tax you’ll need to pay for dropshipping is income tax. Income tax is what you’ll pay the government for your dropshipping profit.

    All dropshipping businesses will pay federal income tax, and almost every state charges income tax, which you’ll also pay. You can pay the federal tax quarterly as estimated income tax payments.

    Dropshippers pay income tax when there’s a profit. If you don’t make any dropshipping profit in a year, you won’t owe income tax. 

    Sales Tax

    The second tax you’ll need to pay for dropshipping is sales tax. Sales tax is a city, municipal, or state tax, which comprises a percentage of a sale.

    You may qualify for a state tax exemption certificate if you plan on reselling the goods. If you plan to resell goods, you can qualify for an exemption certificate in three steps:

    1. The purchaser completes an exemption certificate and provides it to the seller.
    2. The seller will keep the exemption certificate and can sell goods to the purchaser.
    3. These goods will not have sales tax charged.

    How To File Taxes for Dropshipping

    When it’s time to file taxes for dropshipping, you’ll first need to determine which taxes you’ll pay: income tax or sales tax. 

    You’ll pay income taxes no matter where your dropshipping business is based in the U.S.:

  • You’ll pay federal income taxes based on your dropshipping profits. 
  • You may also pay a state income tax, though not every state requires this tax.
  • Depending on where you live, you may have to file both federal income tax and state sales tax. 
  • You’ll file and pay state sales taxes differently than federal income taxes:

  • Consumers will pay this tax, but dropshippers will collect, file, and submit the sales tax payments. 
  • States charge varying percentages for sales tax.
  • As a dropshipping business owner, you should keep records of business sales and sales taxes.
  • Whether you’re filing federal income taxes or state income taxes, you can qualify for tax deductions which can help you when tax time arrives.

    FAQs about Dropshipping Taxes

    Do You Need a Tax ID for Dropshipping?

    A tax ID is a requirement for dropshipping business owners to pay sales tax. Almost every state has a state sales tax, and you’ll need a tax ID to prove that you collect sales tax from a customer’s purchase.

    Dropshipping suppliers don’t charge taxes on products that they ship to your dropshipping’s customers. Because of this, the supplier provides information to the IRS confirming the dropshipping company collects sales taxes on their customer’s orders.

    Do I Need an LLC before Dropshipping?

    You’ll need an LLC before dropshipping because of the protection it provides. Having an LLC before you start dropshipping will protect your business assets and your personal assets. 

    Forming LLCs also offers important benefits for dropshippers, which include:

  • Keeping your business assets and personal assets separate.
  • Protecting your personal assets if your dropshipping business has liability issues.
  • Provides your business credibility with consumers and when applying for grants and loans.
  • What Permits Do I Need for Dropshipping? 

    To do dropshipping, you’ll need a seller’s permit. This permit lets you collect sales tax online, and it also lets you sell products online.  

    There are five states which don’t charge state sales tax. In these states, you won’t need a seller’s permit:

  • Alaska
  • Delaware
  • Montana
  • New Hampshire
  • Oregon
  • Work with an Accountant That Specializes in Dropshipping Taxes

    Dropshipping involves variables for their business owners. For U.S.-based businesses, income tax and sales tax also play a role in how you file and pay these taxes. These are just a few of the reasons you’ll want to work with accountants with dropshipping taxes experience. 

    An accountant with dropshipping tax experience is ready to help. Contact the accounting pros at 1-800Accountant to get support you deserve when preparing your taxes. 

    This post is to be used for informational purposes only and does not constitute legal, business, or tax advice. Each person should consult his or her own attorney, business advisor, or tax advisor with respect to matters referenced in this post. 1-800Accountant assumes no liability for actions taken in reliance upon the information contained herein.