Having an ecommerce business can be profitable enough – that is, until the time to pay taxes comes. Most sellers in the U.S. ecommerce industry unintentionally leave money on the table or subject themselves to huge fines as a result of some tax mistakes. Also, these tax traps can silently decrease the profit margins, especially the Shopify sellers and those managing multichannel activities. Regardless of whether you are new to the business or are expanding your online business, it is important to know these pitfalls and how the Ecommerce Accounting Services will assist you to avoid them.
In this blog, we will be revealing 5 hidden tax pitfalls that can jeopardise the profitability of any ecommerce business and how the Shopify Accounting tools and intelligent financial advisory can assist sophisticated sellers to avoid them.
1. Unpaid or Mis-calculated Sales Tax
Sales tax nexus happens to be among the largest blind spots in ecommerce tax compliance. The U.S. tax laws require you to pay and collect (sales tax) in the states to which you present a nexus. A nexus may be either physical (such as owning a warehouse in California) or economic (such as making $100,000 in sales or 200 transactions in a given state).
Nevertheless, there are so many ecommerce companies that underestimate or miss these taxes. To make it worse, local taxes differ within states, not only by state but also by county and city. Shopify does have built-in sales tax capability, but one has to set it up carefully in order to achieve accuracy in jurisdictions.
Smart Solution:
Use Ecommerce Accounting Services, which incorporate sophisticated tax tracking software. Such services can automate the sales tax calculation, monitor the nexus thresholds and check if your Shopify accounting setup is properly prepared to collect and remit the accurate amount of taxes at the appropriate time.
2. Failing to Account for Inventory Costs
Inventory is the blood of any ecommerce company, on the one hand and, on the other hand, one of the most sophisticated accounting fields. Inaccurate inventory tracking has a direct hit on your Cost of Goods Sold (COGS) that impacts your gross profit and taxes owed.
Most sellers have trouble with such valuation techniques as FIFO (First-In, First-Out) or LIFO (Last-In, First-Out) and would not know how to adjust the COGS properly after applying discounts, damaged goods or returns. What should be ensured that you are not reporting any overstated income or under-claimed deductions, either way, at your expense.
Smart Solution:
Use Shopify accounting features, including inventory control, or hire ecommerce accountants who know how to navigate inventory costs. They will make sure that they record COGS and ending inventory running balances properly, aiding you in procuring all legal deductions and submitting legal tax returns.
3. Mismanaging Income Tax Obligations
The difference between an e-commerce entrepreneur and a normal W-2 worker is that, where on the one hand, the W-2 worker has to pay his payroll taxes (and any federal, state, and even franchise taxes that might exist), the e-commerce entrepreneur must do the same by himself. An unusual pitfall? Estimating tax payments and forgetting or underestimating quarterly tax payments. By forgetting these deadlines involuntarily, the IRS will sanction you by charging interest fees.
Moreover, state income tax may be activated in states where the multistate sellers have no sales tax collection but reach their economic nexus.
Smart Solution:
Utilise Ecommerce Accounting Services, which provide advanced tax planning and forecasting. These specialists will be useful for making approximate payments accurately and will be ready to pay taxes before they accumulate. Others are even Shopify integrated; it helps in automatically syncing revenues and expenses, thus making them tax ready.
4. Neglecting State and Local Taxes
Lesser-known state laws and taxes that ecommerce sellers frequently miss include the use tax, business license fee and franchise taxes, in addition to sales and income tax. Such taxes are highly diverse on the basis of where you are conducting your business and selling it. Failure to comply with these taxes may lead to an increase in fines.
For example, a seller using Shopify in Texas may be required to pay franchise tax in spite of the fact that he/she may not have a physical location. Or the business making purchases of the supplies from outside the state vendor may have a liability for use tax in respect of these purchases.
Smart Solution:
Hire an accountancy team that is tax- and industry-savvy. The most preferred e-commerce accounting services ensure that you are registered, reporting and paying all the taxes that you are liable to pay. This means automating compliance so that Shopify merchants can ensure reduced errors and stay stress-free.
5. Incorrectly Classifying Expenses
Expense classification is one of the silent profit killers if done incorrectly. Most ecommerce entrepreneurs do not differentiate between personal and business expenses and describe costs inappropriately. Considering an example, an advertisement expense, shipping cost, merchant processing charge and Shopify subscriptions should be analysed and classified appropriately to enjoy maximum write-offs and reduce taxable revenues.
It is not only that misclassification causes you to lose potential tax savings, but also that it exposes your business to an even greater audit risk. A vague “miscellaneous” expense line filled with thousands of dollars? That’s a red flag for the IRS.
Smart Solution:
Savvy sellers hire accountants specialised in ecommerce who understand how to code the transactions correctly. Expenses can automatically be imported to Shopify Accounting and categorised according to custom, IRS-compliant categories, so preparing taxes is as simple and audit-proof as possible.
Bonus Tip: Don’t Forget About Quarterly Tax Planning
Most entrepreneurs in the ecommerce business focus only on annual taxes. However, the IRS expects quarterly estimated payments in case you plan to pay at least $1,000 in taxes. Failure to make these payments is penalised with fines and interest, which eats into your profit.
Make an estimate of the amount you are supposed to pay every quarter using accounting software or with the assistance of a professional. Being up to date on payments will result in fewer surprises at the end of an accounting year and a healthier overall financial status.
Wrapping Up
The tax environment of ecommerce is not friendly, and the price of ignoring it is much more significant. Failure to collect sales tax, overlooking cost of inventory and other such five hidden traps of taxes can exhaust your profits without you knowing it.
However, things do not have to be like this. These pitfalls can be circumvented with the use of the proper tooling, by planning in advance and taking expert support. If you own a Shopify store or have a multichannel ecommerce empire, then you should certainly consider purchasing Ecommerce Accounting Services, as it will pay off in higher profits due to saved time, minimised risk, and many other factors.
Do you need assistance with compliance and profitability?
Let our E2E Accounting experts help you with efficient systems that suit your company. Whether it is Shopify Accounting integration or multi-state tax, we take care of the numbers, and you grow.
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