How Taxes Work For Dropshipping Businesses

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Everybody’s favorite topic… taxes.

As un-fun as taxes are to deal with, they are a reality of doing business.

And if you run a dropshipping store, understanding how taxes work for dropshipping businesses is incredibly important so you can be on top of your finances and stay in compliance with legal authorities.

I’ve run a successful dropshipping business and know first hand how much of a headache taxes can be.

I also know that very few, if any, of the online courses that teach dropshipping touch on the subject.

It’s one of those things where having an understanding of your tax exposure at the beginning can make life a lot easier once your store gains traction.

In other words, you don’t want to get into a situation where you’re playing catch up with your taxes.

Quick Disclaimer:

***VERY IMPORTANT, PLEASE READ***


At Wealthiverse, we are entrepreneurs – we are not CPA’s or tax attorneys.

None of this content should be construed as legal or tax advice in any way. You should verify any information you read on this page with a CPA or a tax attorney.

Types Of Taxes You’ll Deal With When Dropshipping

The two types of taxes you’ll deal with as an entrepreneur running a dropshipping business are 1) federal income taxes (state income taxes also if you live in a state that has a state income tax) and 2) state sales and use taxes.

In this article I’m going to focus less on income taxes and more on sales and use taxes for dropshipping businesses.

The reason is because income tax liabilities can vary quite a bit depending on your location, and how you’ve structured your business legally.

To a large extent, income taxes are what the rules are similar no matter what type of online business you’re running.

State sales and use taxes on the other hand often have direct impacts on your tax liability as a dropshipping business, especially as your business pass certain revenue milestones (more on that in a moment).

Here we’ll touch on income taxes but focus more on the concept of state sales and use taxes since these can be more disruptive to dropshipping businesses specifically.

1. Income Taxes

Generally speaking, your net income from business operations will be taxable in one way or another.

If you’re running your business through a sole proprietorship or a pass through entity like an LLC that means the business’ income will eventually be reported on your personal tax return.

You’ll likely have to pay income taxes and potentially self employment taxes (Social Security and Medicare) depending on how your business is set up.

And if you live in a state that collects income tax, you’ll need to pay that on top of state income taxes.

Again, I don’t want to go too far down the income tax rabbit hole because ultimately these rules apply whether you’re running a dropshipping business or any other type of business.

As mentioned above, questions about income taxes should really be directed to a CPA.

2. State Sales & Use Taxes

Sales and use tax is where it can get hairy for dropshipping businesses. And to understand how and when you are liable to collect sales tax, you need to have an understanding of the concept of nexus.

A Quick Primer On The Concept Of Nexus

Sales tax nexus is the connection between a seller and a state that requires the seller to register then collect and remit sales tax in the state.

Certain business activities, including having a physical presence or reaching a certain sales threshold, may establish nexus with the state.

There are a handful of business activities that can trigger nexus but there are three types that especially tend to shop up in dropshipping businesses; physical presence nexus, remote employee nexus, and economic activity nexus.

Physical Presence Nexus For Dropshipping

This type of nexus is the most straightforward. Physical presence in a state creates an obligation to collect and remit sales tax within that state.

Even if all of your business is done “online”, physical presence nexus still applies because you likely have a business address in the state (from when you formed an LLC for example).

Even if you don’t have a business address, your being present physically in a state performing work on your computer is enough to trigger a physical presence nexus.

Physical presence nexus can also be established if you store property at fulfillment centers in a particular state. This is less common to see in a lot of dropshipping businesses I’ve come across but it’s something to note if you’re thinking about warehousing some inventory.

The bottom line: you have to register for sales and use tax in your business’ home state, collect sales tax from buyers in your home state, and remit the taxes collected to the state.

Physical Presence Nexus For Dropshipping

Independent contractors and virtual assistants that work in another state can potentially trigger a nexus where you’d have to register and collect sales tax in the state your contractor or employee works. Each state has different laws regarding a physical presence nexus.

The bottom line: depending on the state, you may have to register and collect sales and use tax in any state where you have hired a remote contractor or employee.

Economic Nexus For Dropshipping

Federal law (arising out of the Supreme Court ruling in South Dakota v. Wayfair) allows states to collect sales tax from merchants based on sales revenue and/or transaction volume.

46+ states now enforce economic nexus.

So if your dropshipping store is hitting certain revenue thresholds and/or order thresholds for orders from a particular state, you are required to register, then collect and remit taxes in those states.

As of 2023, here is a table of economic nexus thresholds by state (this is subject to change if a state updates their tax laws):

StateEconomic Nexus Threshold Measurement Period
Alabama$250,000Previous Calendar Year
Alaska$100,000 or 200 TransactionsPrevious Calendar Year
Arizona$100,000Previous or Current Calendar Year
Arkansas$100,000Previous or Current Calendar Year
California $500,000Previous or Current Calendar Year
Colorado$100,000Previous or Current Calendar Year
Connecticut$100,000 AND 200 Transactions12 Month Period ending Sept 30
DelawareNo Sales TaxNo Sales Tax
Florida$100,000Previous Calendar Year
Georgia$100,000 or 200 TransactionsPrevious or Current Calendar Year
Hawaii$100,000 or 200 TransactionsPrevious or Current Calendar Year
Idaho$100,000Previous or Current Calendar Year
Illinois$100,000 or 200 TransactionsPrevious 12 months
Indiana$100,000 or 200 TransactionsPrevious or Current Calendar Year
Iowa$100,000Previous or Current Calendar Year
Kansas$100,000Previous or Current Calendar Year
Kentucky$100,000 or 200 TransactionsPrevious or Current Calendar Year
Louisiana$100,000 or 200 TransactionsPrevious or Current Calendar Year
Maine$100,000Previous or Current Calendar Year
Maryland$100,000 or 200 TransactionsPrevious or Current Calendar Year
Massachusetts$100,000Previous Calendar Year
Michigan$100,000 or 200 TransactionsPrevious Calendar Year
Minnesota$100,000 or 200 TransactionsPrevious 12 months
Mississippi$250,000Previous 12 months
Missouri$100,000Previous 12 months
MontanaNo Sales TaxNo Sales Tax
Nebraska$100,000 or 200 TransactionsPrevious or Current Calendar Year
Nevada$100,000 or 200 TransactionsPrevious or Current Calendar Year
New HampshireNo Sales TaxNo Sales Tax
New Jersey$100,000 or 200 TransactionsPrevious or Current Calendar Year
New Mexico$100,000Previous Calendar Year
New York$500,000 AND 100 Transactions Previous 4 Quarters
North Carolina$100,000 or 200 TransactionsPrevious or Current Calendar Year
North Dakota$100,000Previous or Current Calendar Year
Ohio$100,000 or 200 TransactionsPrevious or Current Calendar Year
Oklahoma$100,000Previous or Current Calendar Year
OregonNo Sales TaxNo Sales Tax
Pennsylvania$100,000Previous Calendar Year
Puerto Rico$100,000 or 200 TransactionsPrevious Calendar Year
Rhode Island$100,000 or 200 TransactionsPrevious Calendar Year
South Carolina$100,000Previous or Current Calendar Year
South Dakota$100,000 or 200 TransactionsPrevious or Current Calendar Year
Tennessee$100,000Previous 12 months
Texas$500,000Previous 12 months
Utah$100,000 or 200 TransactionsPrevious or Current Calendar Year
Vermont$100,000 or 200 TransactionsPrevious 4 Quarters
Virginia$100,000 or 200 TransactionsPrevious or Current Calendar Year
Washington$100,000Previous or Current Calendar Year
Washington DC$100,000 or 200 TransactionsPrevious or Current Calendar Year
West Virginia$100,000 or 200 TransactionsPrevious or Current Calendar Year
Wisconsin$100,000Previous or Current Calendar Year
Wyoming$100,000 or 200 TransactionsPrevious or Current Calendar Year

Tracking your revenue and transactions by state sounds like it could be a headache, but thankfully most eCommerce platforms like Shopify have economic nexus tracking tools built in to your website backend.

The bottom line: you are required to register with each state that you hit order and/or revenue thresholds. You are also required to collect sales tax on sales to these states once a nexus is established (rules vary by state on when the first order you are required to collect tax on but generally it’s the next order after your nexus is established).

Distinguishing OEM Manufacturers From Distributors

This one causes a lot of confusion in the dropshipping communities I am a part of – and honestly, I get why.

When dropshipping you are most likely sending orders to either a distributor (that disributes/ships for multiple brands), or an OEM manufacturer who only ships their brand.

Both of these types of suppliers will 100% ask you for a sales tax permit from your home state if they are based in the USA.

But it makes a big difference in terms of the SUPPLIER’s potential tax liability whether they are a distributor or a manufacturer/brand.

Why? Because a distributor is technically a reseller.

If you dropship directly from an OEM manufacturer, your business is typically the only reseller involved in the transaction. Because of that, I have found OEM manufacturers to be more accepting of a sales and use tax permit from ONLY your business’ home state as basis to not charge sales tax to your business for sales to ANY state.

Distributors are different because they are reselling too. That means nexus laws apply to them and they are on the hook to collect and remit sales tax for sales to any state THEY have nexus in. So by default, they “should” collect sales tax on sales they ship to any state.

From my experience this one can go both ways depending on how conservative a particular distributor is with their tax policy. Some distributors have been ok to not charge sales tax to a particular state when I tell them I don’t have a nexus there.

Others are more conservative and will charge sales tax for every state that your business isn’t registered in.

It’s confusing that different companies can approach the same issue in completely different ways. Part of the problem is that the dropshipping sales tax issue has really only garnered attention in recent years. The IRS hasn’t provided a ton of guidance on specific rules and guidelines.

Hopefully that changes in the coming years, but for now if you run a dropshipping business you will probably see different suppliers treat tax in different ways.

How Sales & Use Taxes Impact Dropshipping Businesses

Having to collect sales tax on sales your dropshipping business makes can be disruptive in a few ways – and these are things to consider as your dropshipping business grows.

First, collecting tax can potentially add friction to your customers’ purchase. Especially if you are dropshipping high ticket items, an added sales tax charge can make a customer think twice and shop around.

You might also lose a competitive advantage to competing dropshippers who either haven’t established nexus themselves or who are choosing to be non-compliant with their taxes. If another store is selling the same brands as you, and you are charging sales tax when they aren’t, it’s possible customers will purchase with the competitor to save money on their purchase.

Finally it creates an administrative burden for your business. Registering for sales tax with each state and then collecting and remitting the tax creates extra work. Thankfully there are software solutions that can help make this as smooth as possible, but it is still a headache to set up.

Why You Should Prioritize Making Your Business Tax Compliant

The main reason is because you are required to do so by law – if that wasn’t obvious.

Businesses by law must register to collect sales tax in every state in which they have nexus. Especially as states start to step up their efforts to collect taxes from out-of-state sellers who have nexus there, you may be increasingly at risk to receive severe consequences.

If you’ve been dodging taxes for a long time, and a state comes after you, you’ll be in trouble and may owe more in back taxes than you can possibly pay.

And if you ever hope to sell your dropshipping business, it’s unlikely to happen if your business has a bunch of risk from not being tax compliant. Good luck with that! Buyers putting hundreds of thousands of dollars or more are growing more and more savvy on this risk and will absolutely tear your offer to shreds on this point if you aren’t compliant.

Misconceptions About Dropshipping Taxes

Misconception #1 – All Online Sales Are Tax Free

This may have been true in the early days of Internet selling, but today it is completely false, and getting more so all the time. What I mean by “getting more so all the time” is that states are continuously tightening their nexus rules and trying to find other ways to capture revenue from potential taxes on online sales.

Misconception #2 – I Only Need To Charge Sales Tax In My Home State

You definitely need to charge tax to buyers in your home state (except if you live in a state with no sales tax), but your obligations don’t end there. You also have to register and collect tax when selling to buyers in states where you have nexus.

Misconception #3 – I Don’t Have To Worry About Sales Tax Because I Dropship On Amazon

Wrong. Amazon sellers using FBA should actually be worrying about sales tax more than other sellers, since their inventory that is stored in Amazon’s fulfillment centers actually creates a physical presence nexus in whichever state it sits.

Amazon sellers have to track where their inventory is, even when Amazon moves in to a new center, and then register and start collecting sales tax on sales in those states in addition to states where an economic nexus is created.

Misconception #4 – I Can Advertise My Prices As “Tax Included”

This might sound like a clever way to be able to charge MAP prices and compete with prices of competitors who aren’t collecting sales tax.

While it’s possible to do this, some states have strict rules regulating it, and in many cases it is going to be way more complicated than it’s worth.

Not to mention, you are technically selling below MAP if your sales price includes taxes, because you are charging below MAP prices to make the post tax sale amount equal to MAP.

Misconception #5 – Nobody Will Come After Me/I Won’t Get Caught

Maybe. It depends on a lot of factors out of your control. And tax missteps could land you a gentle slap-on-the-wrist, or something much worse. Either way, if you get caught you’ll be paying back taxes and penalties.

Not to mention, your business will probably be unsellable if you are severely out of compliance with tax laws.

Tools That Can Help Manage Dropshipping Taxes

Tools like Avalara and TaxJar can integrate with most eCommerce platforms and automate the collection and remittance of state sales taxes.

No matter which way you slice it, there will be upfront work when you hit nexus thresholds in a new state. But these tools can help ease the ongoing administrative burden of collecting and remitting sales tax for your dropshipping business.

Frequently Asked Questions

How Do You File Taxes For Dropshipping Businesses?

How you file taxes depends on where you are located and how you have legally set your business up. While it might be tempting to do taxes yourself to save a buck in most cases it is better to hire a CPA who understands eCommerce to file your taxes.

How To Set Up Shopify Taxes For Dropshipping?

Shopify has a built in tax compliance mechanism called Shopify Tax that can automatically collect accurate taxes based on your customer’s specific address.

What’s annoying about Shopify Tax is that currently Shopify doesn’t have an integration to remit the sales tax collected automatically to each state.

If you want to automate that process you’ll need to use TaxJar or Avalara. And of course you can always manually remit taxes to each state you’re required to if you don’t want to pay for a subscription.

Who Collects The Taxes When Dropshipping?

You, the merchant are the one who is required to collect taxes.

If you built your website on any reputable eCommerce platform or you’re dropshipping on Amazon, collecting sales tax in a particular state should be as easy as clicking a few boxes after you have registered with the state.

What To Charge For Taxes When Dropshipping?

You are required to collect sales tax at the state, county, and/or municipal level depending on the state you have nexus in. These days most eCommerce platforms like Shopify will automatically collect the proper amount of sales tax on each order.

Final Thoughts

At the end of the day it is on you to make sure your dropshipping business is tax compliant. Playing ignorant is a dangerous route to take and is not likely to get any sympathy from a state that decides to come after you.

As much of a headache as it is, you should take tax compliance seriously from day 1 – it will be much better for your business in the long run that way.

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