Selling products and services on Shopify is convenient, not only for the consumer but also for the merchant. However, e-commerce sales also come with their fair share of administrative duties. One of these duties includes staying on top of your sales tax obligations.
In this article, we will dive into all the Shopify sales tax requirements that you as a business owner will have to understand and oversee.
Figuring out how much Shopify sales tax you owe at the end of your financial year may seem like an intricate or even laborious task. However, once you have the basics down, you’ll be able to expedite the entire process.
Let’s dive right in!
E-Commerce Sales Tax In A Nutshell
Sales tax on goods or services sold online is often referred to as e-commerce sales tax or online sales tax. However, these terms are often misinterpreted because they insinuate that there is a special tax category exclusively reserved for digital sales. This is not the case.
The rapid growth of online sales spurred revisions of already established US tax laws to include e-commerce transactions. This meant that merchants no longer needed an office, warehouse, or even a physical store in order for them to do business online throughout the US.
Because of these tax law changes, merchants now have to charge and collect online sales tax from online shoppers. Sales tax must then be remitted to one or more state revenue departments. However, this tax rule is not carved in stone and doesn’t count in every state.
This is because the collection or remittance of your online sales tax is influenced by a number of factors, such as each sale’s location and nexus. Nexus differs from state to state and refers to the tax obligations that a merchant incurs when that merchant sells a certain amount of products or services in a certain state.
E-Commerce Sales Tax History In The US
So, how exactly did online sales become subject to sales tax? This question will require us to dive a little bit into the history of US tax law.
The Quill Corp. Ruling
Before the boom of e-commerce, remote goods and services were mostly sold through mail orders or via the telephone in the US. Remote merchants were only required to collect and remit sales tax on transactions with buyers in states where these merchants had a physical address.
North Dakota was the first state to pass a new law in the 1990s that required merchants to collect sales tax if they advertised to customers in the state, even if these merchants didn’t have a physical presence in North Dakota.
Following the ruling, Quill Corp., a Delaware catalog retailer that sold office supplies, refused to pay North Dakota’s sales tax. Quill Corp. had offices in Illinois, Georgia, and California, but also sold supplies to North Dakota buyers via mail order and telephone. This led to North Dakota suing the company.
The Supreme Court ruled that Quill Corp. didn’t have to collect sales tax from North Dakota customers. According to the ruling, all companies that didn’t have a physical presence in a state weren't subject to sales tax collection in that state. Keep in mind that this ruling was passed in 1992 when online sales only made up a small piece of the total retail value of most businesses.
The South Dakota v. Wayfair Ruling
About a decade later, Amazon saw the potential of the Quill ruling as an opportunity for online retailers to grow their businesses online without restrictive tax regulations getting in the way.
As long as Amazon didn’t have a physical address or presence in any US state, it wouldn’t have to charge or remit sales tax. This meant that Amazon could sell products or services for cheaper compared to other in-store retailers at the time. Before long, rumors started to circulate that e-commerce purchases from out-of-state companies were tax-free.
More and more people started selling goods online which meant fewer sales taxes were being paid. This led to substantial tax revenue loss, and before long, bills attempting to change how sales tax collection should be implemented for e-commerce sales were petitioned. However, lots of these bills faced heavy controversy and criticism, which delayed the process.
Finally, in 2018, when US e-commerce sales hit $504.6 billion, the South Dakota v. Wayfair ruling was introduced. This ruling overthrew the Quill Corp. ruling and made it possible for states to charge sales tax on all companies that sold e-commerce goods or services in their state, irrespective of their physical presence.
How Economic Nexus Comes Into Play For Shopify Sales Tax
The South Dakota v. Wayfair ruling turned the US e-commerce sales tax requirements on its head. Because of this ruling, each online merchant must now pay sales tax on all e-commerce sales made in the states irrespective of your company’s physical presence. Now, your economic presence, or nexus, holds more value in determining how much sales tax you owe.
Each state has nexus criteria that establish whether an online company can be held liable for sales tax. Nexus criteria do differ from state to state and help to differentiate between non-collecting out-of-state sellers, and brick-and-mortar sellers located within each state.
For example, if you are an online or offline merchant in South Dakota, you will trigger economic nexus when you sell taxable products or services worth $100,000 in the state. You can also trigger economic nexus in South Dakota when you generate 200 separate taxable sales transactions during a calendar year.
Although, when it comes to Ohio’s economic nexus requirements, only merchants who sell over $500,000 worth of goods into the state within a calendar year will have to remit sales tax.
Nexus can also be triggered by affiliate linking, dropshipping, attending trade shows, or by employing someone in another state. This is why it is of the utmost importance to establish each state’s individual sales tax law requirements.
How To Comply With Shopify Sales Tax Requirements
If your business is selling taxable goods or services on Shopify, it is important to remain tax compliant. In some states, like New York, attorneys can actually profit from suing companies that are not paying their taxes. This means there is enough incentive to track the tax compliance of successful online businesses.
In order to avoid any quarrels with the IRS, you have to make sure you are collecting and remitting sales tax correctly. To do this, you have to establish where your company has sales tax nexus and what company goods or services are subject to e-commerce sales tax.
Establish Where Your Company Has Sales Tax Nexus
State Tax Laws
First, you have to have a good understanding of state-by-state tax laws. We recommend hiring a financial expert or lawyer to help you with this. If you don’t take all of these tax laws into account, your business could be subject to fines or audits. Start by learning all the specific tax requirements of each state you are planning on doing business in.
Origin-sourced vs Destination-sourced sales
Secondly, you should have a thorough understanding of origin-sourced sales and destination-sourced sales. Origin-sourced sales are taxed where the seller is located, while destination-sourced sales are taxed at the location where the buyer takes possession of the item sold.
As the merchant, you should be able to tell whether you are based in an origin-sourced state or a destination-sourced state. Note that destination and origin sourcing rules work differently if you are an e-commerce seller with economic nexus. Because of this, Shopify sales will most likely be destination-based.
The Sales Tax Rate
After establishing your sourcing, you will need to determine the sales tax rate for all the locations where your company has economic nexus. Remember, the more your business booms, the more diverse your customer base will become. This means that you could end up selling goods in more states, which means you would have to comply with more sales tax laws.
If you are wondering if there are any states left that have not yet enforced economic nexus laws, then you’ll be happy to know that there are. Unfortunately though, there are very few left, but for now, you won’t have to collect sales tax in these states: Delaware, Montana, New Hampshire, and Oregon.
Are Your Goods Taxable?
Lastly, you have to establish whether the goods that you sell are taxable within each state. In some states, certain products and even transactions are exempt from that state’s economic nexus threshold.
Register For A Sales Tax Permit
After establishing in which states your company has economic nexus, you will have to register with that state’s tax authority and apply for a sales tax permit. A sales tax permit can be free of charge or cost anywhere from $1 - $100.
Collect, Remit, and Report Your Sales Tax Returns
After you have received your sales tax permit and have set up your Shopify account, you’ll need to collect, remit and report your sales tax returns.
Remember, Shopify is not a marketplace facilitator and is therefore not required to collect and remit sales tax on behalf of its sellers. This means that online orders or transactions are combined and then paid out to merchants as one big sum. You will have to keep track of the sales tax that needs to be charged with every transaction yourself.
Tax reporting requirements vary greatly from state to state. You can expect to report your sales tax on a monthly or quarterly basis. Your sales tax reporting frequency will most likely be dictated by your sales volume.
Remember, even if you didn’t collect sales tax from a certain state in a particular filing period, you are still required to submit a tax filing. Not doing so could result in a non-filing penalty.
Use Reconcilely For Easy Shopify Automation
Considering all the tax requirements that you have to stay on top of, it might be a good idea to invest in an online tool that can help you to stay tax compliant. A lot of companies start off doing all of their taxes manually. When using Shopify, this means manually calculating how much sales tax is due on each online purchase.
The problem with this method is that it’s hard to do once you have a significant number of orders to keep track of every month. In order to scale your Shopify business successfully, it would be wise to invest in online software or tools that can automate your tax tasks for you.
Of course, you could also hire someone to take care of your tax needs, but as your business grows, this could become rather costly. If you are starting out, you may not have the means to do this right off the bat, which means you need an alternative solution that will fit your budget.
As previously mentioned, Shopify does not keep track of your sales tax for you. Instead, it pays out a lump sum to merchants each month, which includes sales, tax, return fees, and your month’s profit. This can make it difficult to differentiate between refunds, transaction fees, and your sales tax.
In order to track where your money is coming from and where it is going, you need a tool that will be able to reconcile all of your Shopify orders with accounting software. Reconcilely does just that.
It is an online tool that automatically sends Shopify payments, refunds, and fees from any payment gateway to Xero accounting software in real-time. By utilizing this tool, you’ll be able to effortlessly reconcile your books without any additional effort.
Frequently Asked Questions About Shopify Sales Tax
Does Shopify Automatically Charge Sales Tax?
Shopify does not automatically charge sales tax on purchases. This is because Shopify is not a marketplace facilitator, and therefore, is not required by law to collect your sales tax for you. You have to manually calculate how much sales tax should be charged per product and then add that amount to the asking price of every item.
The amount of Shopify sales tax you need to add will differ based on the state in which you have economic nexus and where you sell your products. In other words, when you sell a product or service on Shopify, all of your prices should already include sales tax. This means you will have to subtract the total sales tax from your profit and then remit it to the relevant tax authority.
For more information, read our article Does Shopify Collect Sales Tax?
How Do I Set Up Shopify Sales Tax?
You need to go to Shopify’s homepage and head over to the menu bar. Click on Settings, and then choose Taxes. Next, you need to identify in which state(s) Shopify should collect sales tax from your shoppers. Fill in your personal information such as your state name and sales tax ID, and then head over to the Tax Calculations section.
You will then be able to confirm whether all your product prices include sales tax. You can also include or exclude sales tax based on your customer’s country. Next, you’ll be able to set up tax charges on shipping rates and stipulate your VAT charges on digital goods.
After you have chosen how Shopify should calculate your sales tax, you can create tax overrides and multiple tax collections to customize your sales tax calculation process for each product.
How Do I Pull Sales Tax Reports From Shopify?
Simply open the Shopify app, tap Store, and then click on Analytics. From there, you can head over to the Reports tab and download your taxes finance report.
Does Shopify Charge VAT?
Like with sales tax, each Shopify merchant will have to charge VAT on their products if their sales meet a location-based threshold. This threshold is dictated by the countries that the buyers live in. You have to collect VAT and then pay it to each tax authority with which you have economic nexus.
For more information, check out our complete guide on Shopify VAT.
Shopify enables millions of merchants to scale their businesses by allowing them to reach more people online. Make the most of this e-commerce platform by taking the time to understand your business’s sales tax needs.
By determining where your business has economic nexus, registering for your sales permit, and filing your sales tax returns on time, you can easily remain tax compliant with your Shopify sales tax.
If you need help reconciling your Shopify sales with accounting software, don’t hesitate to invest in an online tax automation tool like Reconcilely. It can streamline your bookkeeping and accounting to give you a complete view of your financial situation. Check out our free trial today and see how Reconcilely can enhance your Shopify business!
Remember, your goal should be to scale your business over time. So, do all you can now to ease the ongoing growth process of your business. We guarantee that you will thank yourself later for it!