If you’ve launched a dropshipping business with dreams of easy passive income, you might be in for a rude awakening come tax season. From juggling retail sales taxes across multiple US states to navigating customs taxes for international markets, taxes pose plenty of challenges for a dropshipping venture.
But understanding dropshipping taxes doesn’t have to feel like solving a Rubik’s Cube in the dark. Below, learn about the various tax obligations you may face, and how dropshipping taxes work, so you can handle them with confidence.
What taxes do dropshippers pay?
Dropshippers may owe several taxes depending on their business location, where they sell, what taxes are charged by suppliers, and whether products are imported. The four main types of tax a dropshipper may have to pay include:
Self-employment and income tax
Dropshipping generates taxable income for its business owner. As a dropshipper, you will at the very least pay income tax on earnings generated by the enterprise at the federal level, and possibly state income tax in one of the 41 states that levy it. If your dropshipping business is based in any of the following nine states, you only have to file for federal income tax:
1. Alaska
2. Florida
3. Nevada
4. New Hampshire
5. South Dakota
6. Tennessee
7. Texas
8. Washington
9. Wyoming
When it comes to income tax payments at the federal level, obligations vary based on your business structure (e.g., sole proprietorship, LLC, C corporation, etc.). For instance, a sole proprietor or single-member LLC will often pay quarterly estimated taxes to the US Internal Revenue Service (IRS). This means you’ll pay the IRS your estimated tax liability four times a year instead of a lump sum paid annually. If you overpay your quarterly estimated taxes, you’ll get a refund for the year; if you underpay, you may need to pay interest or penalties. You can check the IRS’s requirements to see the tax rules that apply to your dropshipping business.
Say you’re operating a dropshipping business as an LLC based in Michigan. As elsewhere, LLCs in Michigan are considered “pass-through entities” for tax purposes, meaning they are not subject to corporate income tax, and profits pass through to the members. Members won’t pay business taxes on the LLC’s revenues but will pay state income taxes.
For reference, in 2023, the Michigan Treasury charged an income tax rate of 4.05%. On top of the state income tax, LLC members in Michigan pay federal income and self-employment taxes to the IRS at a total rate of 15.3% (7.65% for each). In total, for a dropshipper operating as an LLC based out of Michigan, about 19.35% of income goes to federal and state taxes—not accounting for business deductions that can reduce taxable income.
Sales tax
Sales tax is a percentage of each retail sale that goes to the state and local government. Typically, the buyer will pay sales tax on the transaction, and you (the seller) remit it to tax authorities. Sales tax rates vary by location—including state and municipality.
However, dropshipping complicates matters because you’re an intermediary. You collect sales tax from customers and pass it to the government. You may also be responsible for paying taxes on products purchased from suppliers.
For example, suppose you’re based in Nevada but source cosmetics from Arizona. You pay 5.6% on supplies and then charge customers Nevada’s 6.85% rate—unless they’re in other states where you might have a different tax obligation. If your sales surpass certain sales tax nexus thresholds in another state, you may have to collect and remit taxes there too.
Source tax
Source tax (or origin-based tax) refers to collecting sales tax based on your business location rather than the customer’s. This can be confusing in dropshipping, where sellers do not physically handle products. But the legal responsibility for collecting and remitting tax still falls on the dropshipper, not the supplier.
Several states, including Illinois, Arizona, Pennsylvania, and Virginia, use origin-based source taxing, while others employ mixed systems. You generally don’t have to pay income tax twice—so if your dropshipping business is subject to a source-tax rule, you won’t pay it on top of sales tax in the customer’s destination state.
For example, California uses a modified origin-based system for in-state transactions but destination-based for interstate sales.
Customs tax
Many dropshippers source products from overseas. If you are importing products into the US, the US government may charge a customs tax on those goods. These are sometimes known as import duties or tariffs, and they must be paid before customs officials release the goods to a customer.
In the US, the duty kicks in once you surpass the $800 value threshold. That means any import valued higher than $800 may be subject to customs fees.
- If your shipments are typically single-item orders below $800, you might avoid duties entirely. But bulk shipments can trigger a duty.
- The end customer is technically responsible for customs taxes, though some dropshippers offer delivered duty paid (DDP) shipping and cover these costs upfront (usually baked into product pricing).
Different countries have different de minimis thresholds, as well as different tax rates based on product type—for example, Canada sets it around $20 USD, so be mindful when selling internationally.
When do dropshipping businesses charge sales tax?
- Check if you have a sales nexus in a given state.
- Collect sales tax.
- Apply for sales tax exemption certificates.
It’s wise to consult an accountant or licensed tax professional to confirm if your dropshipping business must collect sales tax. However, here are some basic steps to help you assess your obligations:
1. Check if you have a sales nexus in a given state.
Forty-five US states charge sales tax, each with its own nexus rules. State and local governments primarily look at whether dropshippers have a so-called nexus in the state—a fancy way of saying you have a substantial amount of contact with customers there.
For example, if you live in New Jersey but conduct half of your sales in New York, you probably have a nexus in New York and will be subject to New York sales tax. But if you sell one time to one customer based in New York, you haven’t established a nexus.
States determine whether a nexus exists by looking at two factors:
- Physical presence. If you have a physical presence in another state, such as a warehousing location, you have a nexus in that state. Given that dropshipping is a mostly online business, with dropshippers rarely or never handling products, physical presence does not usually come into play when determining whether a nexus exists. However, establishing a physical office in another state may be enough for a nexus.
- Economic presence. Earning a set amount of revenue in a state may require you to collect taxes. Every state has its own rules for what constitutes sufficient economic presence for a nexus—but it’s safe to assume that if you make more than $100,000 in sales in another state per year, you probably have a nexus there.
It’s worth mentioning that if your dropshipping store operates on larger ecommerce platforms (like Amazon or eBay), states look to whether the platforms have a nexus in-state, not whether your individual sales meet the state threshold. Fortunately, most of these larger ecommerce platforms handle the sales tax piece automatically.
2. Collect sales tax.
If you have a nexus in a given state, you can start collecting sales tax by obtaining a tax permit or tax ID from the state. Every state has different rules, but state treasury departments or state tax boards usually have information on their websites about the entire process.
3. Apply for sales tax exemption certificates.
Some states grant reseller or dropshipper exemptions. It’s best to seek professional advice from an accountant about whether your particular business qualifies. One to be aware of is the reseller’s tax exemption certificate from the Multistate Tax Commission. Because dropshippers are considered resellers in some states, the exemption certificate might get you out of paying sales tax. But keep in mind that many exemptions don’t apply in all states. The resale certificate, for example, only applies in 36 states.
How Shopify can help dropshippers collect taxes
Shopify automates the sales tax process for you. It automatically collects tax on every sale executed through your individual site, taking into account both the location of your Shopify store and the customer’s location.
Shopify’s automated sales tax collection tool can even help you assess whether you have a nexus in a particular state and calculate the correct sales tax rate.
Dropshipping taxes FAQ
Do you have to pay taxes for dropshipping?
Yes. Dropshipping is an ecommerce retail business, so you must pay federal income tax and often state income and sales taxes as well. Depending on product sourcing, source tax and customs tax may also apply.
Should I charge tax on Shopify dropshipping?
If you meet a nexus in a state that requires sales tax, yes. Use Shopify’s tax tool to assess whether sales tax applies to your transactions. If needed, Shopify automatically collects sales tax on each product a customer buys through your store.
Do I need a tax ID number for dropshipping?
Unless you are operating your dropshipping business as a sole proprietor and using your Social Security number as your tax identification number, you will likely need a tax ID from the IRS for your business. You may also need a tax permit from the states in which you are subject to sales tax. A qualified tax professional can help you better understand the requirements for your individual business.