Dropshipping Taxes: Definition, Types, & How to File

Small businesses use dropshipping to fulfill customer orders without the need to keep the products physically in stock. It’s a great way for retail businesses to save space, time, and money. Dropshipping is rising — the global market value is projected to reach $1670.1 billion by 2031. Use this blog as your guide to dropshipping, including details on types, tax obligations, and other information you need to know about starting your own dropshipping business or adding this feature to your current small business operations.

What Is Dropshipping?

Dropshipping is a business model and method of selling goods through a store or e-commerce platform/website without storing that 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. Typically, a sales tax nexus occurs once your business reaches a certain revenue or transaction threshold in a state.A dropshipping business has a nexus for income tax when it:

• Derives income from sources within the state.

• Has capital assets or property within a state.

• Have employees there engaging in work. 

• Leases or owns property there.

Dropshipping businesses may have a sales tax nexus in their 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 many platforms available to help streamline your dropshipping business. Some of 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 because both tax nexus types can trigger dropshipping owners to pay taxes. As a result, you’ll pay two main taxes for dropshipping: income tax and sales tax. But there are other taxes to learn about, which we will detail below. 

Income Tax

Income tax is what you’ll pay the government for your dropshipping profit.All dropshipping businesses will pay federal income tax to the Internal Revenue Service (IRS), 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. You won't owe income tax if you don’t make any dropshipping profit in a year.We offer personal income tax preparation and filing services that save time and ensure compliance. Schedule a free consultation today to learn more. 

Sales Tax

Sales tax is a city, municipal, or state tax that 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.

Source Tax

Source tax is paid to the supplier your dropshipping business uses to fulfill customer orders.The actual amount your dropshipping business will pay depends on a number of factors, including product category and the supplier's physical presence. Some dropshipping businesses can qualify for an exemption from this tax. If approved, your business would not be responsible for paying a source tax to your supplier. 

Customs/Duty Taxes

If your suppliers import the goods your dropshipping business sells from outside the country, you will be responsible for customs or duty taxes. This tax applies to most businesses importing goods and products into the United States. 

How To File Taxes for Dropshipping

You’ll first need to determine which taxes you’ll pay: income tax or sales tax to address your tax liability by the approaching filing deadlines.You’ll pay income taxes no matter where your dropshipping business is based:

• 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 retain records of business sales and sales taxes.

Whether you’re filing federal or state income taxes, you can qualify for tax deductions, which can help when tax time arrives.

Work with an Accountant That Specializes in Dropshipping Taxes

Starting your dropshipping business is exciting, but getting the details right can be nerve-racking. This is why so many small business owners and entrepreneurs trust the tax professionals at 1-800Accountant, America’s leading virtual accounting firm, to address their distinct dropshipping requirements.Whether you need small business taxes, bookkeeping, or any of our professional accounting services, we have the solution you need at a price that works within your budget. Schedule a quick consultation—usually 30 minutes or less—to learn how our tax experts can help your dropshipping business.

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.

Do I Need an LLC before Dropshipping?

Forming your dropshipping business as an LLC is optimal due to the protection this entity type provides. Creating an LLC before you start dropshipping will protect your business and personal assets.Forming LLCs also offers important benefits for dropshipping businesses, which include:

• Keeping your business assets and personal assets separate.

• Protecting your personal assets if your dropshipping business has liability issues.

• It provides your business credibility with consumers when applying for grants and loans.

Form your LLC the right way with 1-800Accountant's entity formation service. 

What Permits Do I Need for Dropshipping?

You're required to obtain a seller's permit to operate your dropshipping business in most states. This permit lets you collect sales tax and sell products online.  

U.S. states that don't require a seller's permit include:

• Alaska

• Delaware

• Montana

• New Hampshire

• Oregon

When Do I Need to Pay Taxes as a Dropshipping Company?

All dropshipping businesses will pay federal income tax. Your business will also pay state income taxes if it operates in a state where that income is taxed. You can pay the federal tax quarterly as estimated income tax payments.

Making the right quarterly estimated tax calculations and submitting them by each deadline is easy with 1-800Accountant's full-service quarterly estimated tax solution for your dropshipping business. 

What Deductions are Available to Dropshipping Companies?

Tax deductions reduce your dropshipping business's taxable income. There are numerous tax deductions your dropshipping business can take advantage of, including deductions associated with advertising and marketing, travel and transportation, and professional fees, such as being able to deduct professional accounting services.