This article delves into the various taxes that e-commerce businesses in the US may be liable to pay.
1) Custom tax for ecommerce Businesses Operating in the US
If you ship products from other countries into the US, the product may be subject to Custom tax. Usually the shipping company (for example DHL) may forward the custom tax rate to you, the sender of the item or your customer the receiver of the item.
When shipping products internationally into the US, the shipping company may ask you to declare the product price on your shipment order, the product price you declare will often be used to calculate the applicable custom tax rate.
Note that if you intentionally declare a price that is obviously little compared to the product being shipped, US customs may request proof of the product price in which case the shipping company may contact you to prove that your declared price is the actual price of the product.
If you’d like to pay the custom tax rate yourself and not have the custom tax bill forwarded to your customer, it’s important to communicate this need with your international shipping provider, they will guide you on how to ensure that custom tax bills are forwarded to you and not your customer.
In the US The import tariffs (Custom tax) vary between 0% and 37.5 %, with 5.63% being the average.
2) Sales tax for ecommerce Businesses Operating in the US
Sales tax in the United States isn’t a federal tax; instead, it’s administered at the state and local levels. While both local and state governments have the authority to enforce sales tax, its regulation is primarily managed at the state level.
In the US each state has its own sales tax laws. A business will be required to charge sales tax and remit it to the state when they have reached a sales threshold or has an economic nexus in that State.
Businesses must register for sales tax in each state where they meet the sales threshold, economic nexus standards, or any other state-specific requirements.
“Economic nexus” is an Umbrella Term that signifies the economic link of a Business to a US state. Once an out-of-state seller, meaning a seller operating outside the state but making sales to customers within it, meets the state-defined economic nexus criteria, they become obligated to collect and remit sales tax to the state government. Each state defines its economic nexus, which may include factors like maintaining a warehouse, having employees, or reaching a specified number of sales transactions within the state.
In the US, sales tax is primarily regulated at the state level, and every state has different laws and rules.
For many US states a common sales tax Economic nexus is determined by reaching a sales threshold of 200 transactions or $100,000 in sales in the previous or current calendar year (in that particular state).
For example, Maryland recognizes economic nexus for any Business that reaches the sales threshold of more than $100,000 in gross revenue or 200 or more separate transactions, whichever the business reaches first. Once a Business has met this threshold then it’s required to start charging sales tax and remitting it to the Maryland State Government.
The sales tax rate is determined by each state and may include additional rates imposed by local governments within the state. A state can have its defined Sales tax percentage rate, the local government can have its own additional local sales tax percentage rate for products sold to customers residing within that local Government in the state.
In the US five states have a statewide 0% sales tax rate. These are Alaska, Delaware, Montana, New Hampshire and Oregon. Of these 5 states that forego statewide sales taxes, only Alaska allows localities to impose local sales taxes.
In this Article, we go in depth on how sales tax applies to e-commerce Dropshipping Businesses.
In this Article we discuss how you can automatically calculate and remit Sales tax at low or no cost as an ecommerce start up Business and how you can automate and manage sales taxes as a medium sized Business.
3) State income tax for ecommerce Businesses Operating in the US
Generally, State income tax is a tax charged on the personal income of people who live and work in a State or Business that have state sourced income. Specific criteria for charging State income tax rate varies from state to state.
If you have US sourced income in multiple US states then you may be subject to pay State income tax in those multiple US states except for states where you qualify for a State income tax exemption, state reciprocity agreement benefit or other similar state tax exemption or waiver.
The state determines the State income tax rate. Each US state determines how much their State income tax would be for individuals and Companies within the State.
State income tax for individuals can range from as low as 2.5% in Arizona to a high of 13.3% in California. whereas State income tax rates for Corporations range from 1% to 12% (although some states impose no State income tax).
The only states that do not levy an individual state income are; Alaska, Florida, Nevada, New Hampshire, South Dakota, Tennessee, Texas, Washington, and Wyoming. The states that do not have Corporate income tax are; South Dakota, Texas, Washington and Wyoming.
US State income tax annual filing deadlines vary by state, but for individuals, state tax day usually falls on the same day as federal tax day, which is typically April 15 every year.
What is US state-sourced income for the purpose of determining the Obligation to pay State income tax?
The rule for determining US State source income is generally determined by the location where the services are performed. US State source income is therefore the portion of income attributable to services performed in that state.
If you have a Business that uses the dropshipping fulfilment model, you are not resident in a certain US state but have customers in that US state, will you be said to have US sourced income in that state? The answer is No!
This is because in this case, you are basically a marketer, promoting products via your computer and operating from an out of state location, even if you have customers in that state, your service was not performed within the state and so you do not have State sourced income.
If the product is shipped to the customer from a third-party supplier situated in that state, the supplier, as a business providing fulfilment services, is the one with state-sourced income (not you), unless the supplier is your direct employee (not operating as its own business) and is directly answerable to you.
Does non US resident LLC pay state income tax?
What is Non US resident LLC? Non US resident LLC refers to an LLC that is registered in the US while all members of the LLC do not reside in the US and operate the Business from outside the US under the name of the US LLC.
Generally an LLC is a “pass through” entity which means that the obligation to pay tax is not on the LLC as an entity but rather passes through to the members of the LLC. Since the members are non US residents, they will not be required to pay state income tax except if they have State sourced income.
In simpler terms does the LLC have workers and employees who are answerable to the LLC (not independent Business Partners which have their own independent Business structure and management like a 3pl service), if the LLC have workers and employees who are answerable to the LLC within the state then the LLC is said to have State sourced income and may be liable to pay State income taxes.
On the other hand, if the LLC operates remotely from outside the state, even if the LLC has customers in the State and the LLC partners with a state based Independent Agent like a 3PL service for delivery of products to customers within the State, since the LLC does not operate its own Business from within the state (i.e having direct employees that are resident in the state), then the non resident LLC does not have State source income and therefore not subject to state income tax.
The obligation to pay the State income tax is determined by where the core business operations and employee activities are based. Independent Agent Activities do not count.
Do LLC owe any filing Obligation to their Registered state government, if they do not Owe any State income tax?
In the US different states have different filing requirements for LLCs, so whether or not you owe States income taxes, you may still need to make other filings as an LLC to your registered states.
Typically some states may require LLC to file an annual report, Announce the formation of the LLC in a publication, as an e-commerce start up LLC you may be required to apply to the State for a Sales permit, a Reseller Certificate or a DBA (Doing Business as) Certificate.
We recommend reading this Article where we summarise the different filing requirements for LLC’s registered in the 50 US states and our recommended states for registering an LLC specifically for e-commerce start ups, if you want less paperwork, if you do not want periodical state filings and little to zero taxes.
4) Federal income tax for ecommerce Businesses Operating in the US
the United States presently employs a progressive federal income tax system comprising seven brackets. These brackets are structured with corresponding rates of 10%, 12%, 22%, 24%, 32%, 35%, and 37%. It’s important to note that these tax rate brackets are applicable to individual income, and the rate increases as one’s income moves into a higher bracket. This progressive system aims to impose higher taxes on higher levels of income, reflecting a tiered approach to taxation.
Since 2018, C corporations in the United States have been subject to a flat federal income tax rate of 21%, following the implementation of the Tax Cuts and Jobs Act (TCJA).
Federal income tax in the United States is typically imposed on businesses with U.S.-sourced income. The specific manner in which federal income tax is applied varies based on the tax structure of the business.
For example US LLC with the default LLC tax structures will be charged federal income tax on the individual level, thus this means that members of the LLC will become responsible to pay federal income tax and not the LLC itself as a separate entity. Since an LLC is a “pass through entity” the tax obligation passes through to the members of the LLC.
Income tax can be charged both on the LLC as a separate entity and on the members of the LLC as well, if the LLC has elected to be treated as a C-corp for income tax purposes, which may lead to double taxation.
An LLC can also elect to be treated as an S-corp in this case, federal income tax will pass through to the members of the LLC with an added benefit being that members can distribute dividends to themselves and take salaries which are not subject to income tax thereby reducing how much members can pay in federal income tax.
For a more detailed and comprehensive Article on US Business entity types and tax structures and to see our recommendation for e-commerce start-ups, check out this Article.
The deadline for taxpayers to file their annual Federal income tax returns is typically April 15.
What is US sourced income for the purpose of determining the Obligation to pay US Federal income tax?
Income tax is paid on US sourced income to the Internal Revenue Service (IRS), so what is US sourced income?
The rule for determining US source income is generally determined by the location where the services are performed. US source income is therefore the portion of income attributable to services performed in the US.
If you have a Business that uses the dropshipping fulfilment model, you are not resident in the US but have customers in that US, will you be said to have US sourced income? The answer is No!
This is because in this case, you are basically a marketer, promoting products from your computer and in a Country, outside the US, even if you have customers in the US, your product promotion service was not performed within the US and so you do not have US sourced income.
If the product were shipped to the customer from a third party Supplier in the US, it’s the supplier that is a Business who is performing it’s Business fulfilment Services in the United States and so the Supplier has US sourced income (and not you) except if the Supply is your direct employee (not it’s own Business) and is directly answerable to you.
Does non US resident LLC pay federal income tax?
Let’s talk about LLC’s that are owned by non US residents registered in the US, will they be required to pay US federal income tax?
Generally an LLC by “default” is a “pass through” entity accepted if the LLC elected by filling the appropriate forms to the IRS to be treated as a C-corp. An LLC is by default a “pass through entity” which means that the obligation to pay tax is not on the LLC as an entity but rather passes through to the members of the LLC. Since the members are non US residents, they will not be required to pay state income tax except if they have State sourced income.
In simpler terms does the LLC have workers and employees who are answerable to the LLC (not independent Business Partners which have their own independent Business structure and management), if the LLC have workers and employees who are answerable to the LLC within the US then the LLC is said to have US sourced income and will be liable to pay US federal income taxes.
If the LLC does not have direct employees/dependent Agent in the US but rather operates their Business remotely from outside the US. For example, from an office outside of the US, even if the LLC has customers in the US and delivers products to the US through a US based independent agent, for example a fulfilment centre, since the LLC does not operate Business from within the US and has no direct employees in the US, then the LLC does not have
US source income and is therefore not subject to US federal income tax.
Do LLCs owe any filing Obligation to the IRS if they do not Owe any federal income tax?
Yes, Once you are a registered Business in the US, you need to fill the appropriate forms for your Business to the IRS Annually to report that your Business exists even if you do not owe Federal income taxes, you still need to fill some forms to the IRS annually.
Fortunately, IRS income tax returns can be filled online and can be filled for free if you do it yourself but you need to ensure that you are filing your returns to the IRS before the US Federal income returns typical annual deadline of 15th April.
The tricky thing is that there are different returns forms you may have to file depending on your Business entity type and situation like if you are a US resident or non resident.
If you are a US Non resident, you typically do not have a US Social Security Number, and will need to apply for a US Individual Tax Identification Number (ITIN) from the IRS.
Importantly, in this Article, we will work you through on which specific Forms to fill to the IRS annually if you are a non resident US single member or multi member LLC.
If you are a Corporation or US resident LLC, we recommend using H&R Block for US tax consulting for your Specific Business situation and for filling your US Business taxes.
5) Business Franchise tax for ecommerce Businesses Operating in the US
Businesses’ obligations for franchise tax are uniquely defined by each state. In certain states, only C corporations bear the responsibility of paying this tax. However, in other states, the scope widens to encompass S corporations, partnerships, and limited liability companies (LLCs).
As of 2021, a total of eighteen states, including Alabama, Arkansas, California, Delaware, Georgia, Illinois, Louisiana, Mississippi, Missouri, Minnesota, Nevada, New Hampshire, New York, North Carolina, Oklahoma, Tennessee, Texas, Vermont, and the District of Columbia, implement some variation of a franchise tax on businesses operating within their jurisdictions. It’s noteworthy that the franchise tax in Illinois is set to phase out gradually until the year 2024.
The name used to refer to franchise tax can differ based on the state, with various alternative names in use. These include business entity income tax, business privilege tax, business profits tax, commerce tax, corporate franchise tax, net worth tax, and unincorporated business franchise tax.
It’s crucial to distinguish franchise tax from state income tax, as they operate on distinct principles. State income tax is based on a business’s profit, while a franchise tax might be applicable irrespective of whether the business earned income in the state.
It is important to know the specific requirements for paying Franchise tax in the states in which your Business may have nexus (physical or economic nexus).
For example, any business that is incorporated in the state of Delaware, it’s a must—regardless of where the business operates—to file and report an annual franchise tax. For Delaware LLCs or LPs, the annual franchise tax is a flat rate of $300.
California also imposes the Franchise tax on all businesses registered with the state, excluding tax-exempt entities like nonprofits.
California registered Businesses have an annual Franchise tax obligation, paying either a fixed amount of $800 or a percentage based on their net income—whichever sum is greater. The applicable Franchise tax rates depend on the business’s tax classification: C corporations at 8.84%,
S corporations at 1.5%, and partnerships (including LLCs, LPs, LLPs, LLLPs) have a flat annual Franchise tax of $800.
We recommend reading this Article where we summarise the different filing requirements for LLC’s registered in the 50 US states and see our recommended states for registering an LLC specifically for e-commerce start ups, if you want less paperwork, if you do not want periodical filings and little to zero taxes.
7) FICA Payroll taxes for ecommerce Businesses Operating in the US
Employers are legally obligated to withhold FICA taxes from both employee wages and their own income and remit same to the IRS.
Businesses with U.S. resident employees and employers earning U.S. sourced income are subject to FICA payroll taxes.
Businesses are required to report FICA taxes quarterly through IRS Form 941, This form is for reporting business information that includes the number of employees, as well as amounts withheld from their paychecks for income taxes, social security, and Medicare. Additionally, Form 941 reports the employer’s share of social security and Medicare FICA taxes. The due date for Form 941 is the last day of the month following the close of each quarter, for example, April 30 for the January 1 to March 31 period.
The FICA tax burden is shared between employers and employees, with current rates standing at 6.2% for Social Security and 1.45% for Medicare. Each party, both the employee and employer, contributes 7.65% of their income, culminating in a collective FICA contribution of 15.3%.
Non US Resident Employers and Employees, who do not have US sourced income are exempt from FICA Payroll taxes.
If you are a Corporation or US resident LLC, we recommend using H&R Block for US tax consulting for your Specific Business situation and for filling your US Businesses taxes.
8) Self Employment taxes for ecommerce Businesses Operating in the US
As a self-employed U.S. resident with U.S. sourced income, you’re obligated to pay Social Security and Medicare taxes on your net earnings, calculated as your gross income minus deductions. Notably, self-employed individuals don’t pay FICA taxes like typical Employers and Employees; rather, self-employed persons are required to fulfil their Social Security and Medicare taxes responsibilities by paying “SECA” taxes under the Self-Employed Contributions Act. The self-employment tax rate stands at 15.3%.
Determining whether you’re classified as a self-employed owner or an employee for tax purposes can be somewhat confusing. Generally, business owners actively engaged in a corporation are treated as employees, subject to FICA tax withholding. The IRS typically considers individuals as self-employed if they fall into the following categories:
- Owner of a sole proprietorship or independent contractor.
- General partner in a partnership.
- Member of a limited liability company (unless the LLC is taxed as a corporation).
There’s a silver lining for self-employed business owners. They have the benefit of deducting half of their SECA (Self-Employed Contributions Act) taxes when filing their income tax returns.
Non US Resident Employers and Employees, who do not have US sourced income are exempt from FICA Payroll taxes.
If you are a Corporation or US resident LLC, we recommend using H&R Block for US tax consulting for your Specific Business situation and for filling your US Businesses taxes.
Conclusion
In conclusion, navigating the tax landscape for e-commerce businesses operations in the US involves addressing various tax obligations at the federal, state, and local levels. This comprehensive overview covered key aspects, including custom tax for international shipping, sales tax obligations based on economic nexus, state income tax considerations, federal income tax implications for different business structures, and the unique franchise tax requirements in specific states. Additionally, it highlighted the importance of understanding FICA payroll taxes for businesses with US resident employees and the self-employment tax responsibilities for individuals categorized as self-employed.
The complexity of these tax regulations emphasizes the need for careful consideration and compliance to ensure the financial health of e-commerce ventures. For detailed insights into each tax category and recommendations tailored to e-commerce startups, readers can refer to the specific sections within this article.
