Taxes In Drop Shipping Business: What Tax Experts Say?
Every type of business has an official part.
Drop shipping business is not an exception — as you remember, we have already discussed the ways and benefits of registering your enterprise on the territory of the USA.
This article witnessed a huge interest, and numerous readers asked us about the taxation part. How could we resist?
To answer all your questions in a correct and professional way, we asked for the expert help.
Meet a tax expert — Sergei Suslov — Certified Public Accountant (CPA), Chartered Global Management Accountant (CGMA) and Ph.D. in Economics. Sergei has more than 28 years’ experience in accounting, taxes, audit and finance. His firm SVS Accounting LLC concentrates on business and individual income tax preparation. Servicing nonresidents doing business in the United States is one of the firm’s major specialty. This accounting company is located in the state of New Jersey, nearby New York City, and it is servicing clients in all 50 states of America.
Please welcome Sergei in our blog!
Sergei Suslov — CPA, CGMA, Ph.D. in Economics
Dear fellow entrepreneurs,
Before answering your tax questions, I’d like to make two general remarks about American tax system.
First, tax issues are taken very seriously in the United States. Everyone must pay! Even the famous Chicago gangster Al Capone was jailed back in 1931 not for racketeering and murders, but for the tax evasion.
All Americans know the phrase belonging to one of the country’s Founding Fathers — Benjamin Franklin (the guy on a $100 bill): “Nothing is certain but death and taxes”. So, do your best to follow the rules!
Second, with American tax system and especially international taxation is rather complicated. To make your life easier and avoid any troubles, it’s better to hire a good professional accounting firm with non-resident taxation experience.
Remember, you as a business owner have the final responsibility for taxes, so be careful! In this article, you will find a piece of advice on choosing the right accountant.
Now, let’s go to the readers’ questions!
Q: What is the best US state to register a simple LLC for non-residents?
For a drop shipping business, you have to consider two of the most important tax parameters: state income tax and state sales tax. Some states, for example California and New York, have complicated tax reporting requirements and high tax rates. Some states do not require filing a state income tax return at all. Nevertheless, all states charge annual filing fees from the registered businesses. The same relates to a Sales tax, which we will discuss later.
From my experience, the most convenient and business-friendly states are Wyoming, Delaware and Nevada. They have no state income taxes for the businesses operating outside these states.
Q: What are the tax filling requirements if you have a US company? Who handles the tax requirements of the LLC company if you live outside the US?
There are two main types of taxes in the Unites States: Income Tax and Sales Tax. In addition, there are several levels of taxation: Federal, State and, sometimes, City.
Income tax is a tax on net income.
It is calculated with the help of the following formula:
(Gross receipts from the business — all allowed business expenses) * Tax rate.
It is calculated on the basis of federal tax rates for a federal income tax return, state tax rates for state tax returns, and city rates for cities. The three business-friendly states mentioned above do not have Income tax requirements on the state level.
Every business entity is subject to Income Tax reporting requirements, with a few exceptions. These reporting requirements exist even if you do not have an income or even if you have a loss. Of course, you only have federal income tax reporting requirements if you have registered your business in the non-income tax state.
Businesses must file income tax returns on time regardless of the net income amount. Punishment for LLC’s latefiling is simple — $195 per member for every month of delay up to 12 months. So, for two partners it could be up to $4,680 for one year delay. Corporation late filing penalties depend on the net income amount, and federal fines could be more moderate, but States usually hit hard following their state tax laws.
Sales tax is an extra charge on the goods sold in retail sales. Sales Taxes are levied by States (not a federal government) from the businesses located within their jurisdictions. They are applied to the retail sales made to the same state residents. For example, if you registered your business in the state of Delaware and sold goods to New York residents without presence in New York, you owe zero Sales Tax to either state. So, if you sell a $100 item you charge your client for $100 and this amount is your Gross Revenue.
If you registered your business in the state of New York and sold goods in the same state, you have to pay Sales Tax to the state (and possibly to the city) of New York. In this case, if you sell a $100 item you charge your client for $100 + 8.75 NY Sales tax. A $100 is your Gross Revenue and $8.75 is a Sales Tax amount, which you must pay to the state of New York. From a tax planning point of view, the conclusion is simple: do not register your drop shipping business in the state where you are going to have the majority of your online sales.
Your accountant will calculate the sales tax amount, make necessary sets up with the state and arrange automatic tax withdrawals from your bank account. All you need to do is keep enough money in the bank.
When you have established an American company, your personal place of living is not related to the reporting requirements. For most businesses, you hire an accounting firm which monitors these requirements and lets you know when it is time to report and pay taxes. Nowadays international communication is not a problem, all your business affairs with your accounting firm could be arranged through the internet, telephone and mail service. Again, the key issue is to find a good accountant, everything else will be easy.
Before doing your taxes, an accountant will need to do your books. We call this process bookkeeping, or write up. During bookkeeping process, an accountant records all your financial transactions into the books and allocates them between accounts in accordance with rules and regulations. If you had a business in your country, you must be familiar with this procedure. Of course, the rules of bookkeeping are different from country to country.
Q: What is Income Tax Return?
Tax Return is an American name for an income tax declaration — a document existing in most countries around the world. Your accountant prepares this document for you every year. It reflects all your business gross receipts, all allowed by tax law expenses, and calculates taxes on the net income (gross receipts less expenses). In most cases, it is mandatory to prepare and file the annual income tax returns to tax authorities.
Nevertheless, there are some situations when you can avoid filing. For example, if you registered a single member LLC and did not have any activity during the year, you can skip filing for this year. If you have a loss, the tax filing could be favorable for you, because the loss will be forwarded for 20 years ahead and your future taxable income will be decreased. The similar circumstances for a multi-member LLC could be more complicated. It is better to discuss this issue with your accountant. A Corporation must always file the tax return, no matter what.
Q: When do we need to file income tax returns?
LLC’s and Corporations income tax returns are paid once a year, usually on or before March 15 of the next year. Nevertheless, the government wants you to pay ¼ (25%) of your future annual taxes every three months (quarterly). Because nobody is capable to predict the future, accountants use estimates. It is advisable, but not obligatory to make these quarterly advance payments (estimates). If you ignore them, Internal Revenue Service simply accrues interest on underpaid taxes at 2–3% annual rate, and you will pay it along with your regular taxes after yearend.
For example, your annual taxes were $10,000. You had to pay $2,500 in April, June, September and December, but you did not. IRS will accrue additional amount as follows: $2,500 x 3%/12 x 8 + 2,500 x 3%/12 x 6 + 2,500 x 3%/12 x 3 = $106.25
Q: How much should we pay for accounting services?
Every business will need a bookkeeping service and federal income tax return preparation. Depending on the state and city registration, you may have additional state and city income tax filing requirements. If your business is subject to the Sales Tax, you will need to file Sales Tax returns. To do all this reporting, you hire an American accounting firm. Every accounting firm sets up their own pricing system. They could charge you separately for every service or set up the flat fees for all reporting together. For example, our firm charges separately:
- Bookkeeping — starting from $25/month;
- Sales Tax returns — $100 per three months (a quarter) on average;
- Income Tax Returns — mostly $750 (once a year, including federal and one state).
These prices are not written in stone and could fluctuate. We believe to have the best prices on the market in terms of the quality/cost ratio.Of course, nobody wants to pay too much, but low prices could lead to the trap of an incompetent “specialist”. You can save hundreds on accounting fees, but lose thousands on extra taxes and penalties. Nothing could be more expensive than a cheap accountant.
If you are interested in more details regarding taxation of non-residents doing business in the United States of America, you can find them here.
We are really thankful to Sergei for this professional insight.
Of course it is impossible to cover all the possible taxation aspects in a single article, so feel free to leave your questions in the comments section below! They will also be answered by our dedicated expert.
This post originally appeared on AliDropship blog.