How to manage Shopify Taxes: 5 Must Know Deductions to Maximize Profits
Shopify taxes are enough to make any merchant’s stomach churn.
There are so many things to consider – from filing forms and accurately deducting expenses to calculating sales tariffs – it’s not unusual for merchants lose more than a few nights sleep over eCommerce taxes.
It doesn’t have be this way. You can get rid of the stress of managing Shopify taxes with a little bit of knowledge and be able to rest assured that everything is under control.
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This resource will help you manage your taxes thanks to our partnership with Free Cash Flow Agency.
Alan Chen, Co-founder (CPA), will teach you proven methods to avoid tax pitfalls and comply with government regulations. This will allow you to maximize your money.
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The #1 Mistake eCom Entrepreneurs Make in Bookkeeping
I lived a double existence during April 2020, when the COVID-19 pandemic was at its peak.
My day job was as a CPA (Certified Public Accountant) and my night job was in the exciting world that is online ecommerce.
It was amazing to see how an entrepreneur could post insane screenshots of revenue figures between 6 and 7 figures like these:
But many eCommerce owners fail to realize that they are making a serious mistake if they only focus on the top-line revenue.
Although huge screeshots can be a great way to boost your ego, they don’t tell you much about the success of your business.
You must keep track of your Net Profit.
After you have paid all expenses, such as ad spend or product costs, your Net Profit shows you how much money you have left in your bank account.
This formula can be used to calculate net profit:
Revenue = Cost of Good Sold + Operating Expense = Net Profit
Now for the missing piece of the puzzle
Okay, net profit is more important than top line revenue. However, there is one missing element in the above equation…
- Magento Pos
- Shopify Pos
- Bigcommerce Pos
- Woocommerce Pos
- Netsuite pos
- Bigcommerce automation
- Shopify automation
It is the formula. Here’s the formula:
Revenue = Cost of Good Sold + Operating Expense Taxes (Federal and State Sales Tax)= Profit
Write down everything you have read in this article and refer to it whenever you make business decisions for your company.
The United States has many tax options. However, they can consume up to 40% your Net Profit.
This means that a company that believes it’s making $500,000 per year in profits might actually make $300,000. This is $200,000 gone, just like that.
We have learned a lot from our own experience and discussions with hundreds of eCom shops about ecommerce tax and accounting.
This is why we created this guide. Let’s continue to learn how we can help you:
- Your business will make 15-20% more profit in the coming year
- Make sure you are familiar with key tax deductions and credit to ensure your business doesn’t face any financial obstacles or cash flow problems that could prevent it from scaling the world.
Why managing your Shopify taxes is crucial for success
Let’s look at how we are currently keeping track of our bookkeeping.
You are probably familiar with how to navigate Shopify’s dashboard and track your sales over time.
This is a fantastic start!
What about your merchant fees? What about your Merchant Fees?
What about your ad spending? It is important to understand where you can find the total ad spend for your Facebook and Snapchat ads.
Why are you asking me if you can track these numbers?
These are tax-deductible expenses for an eCom company at a deductible of 100%.
These aren’t all the items that can be deductible. You can also make huge savings by tracking your expenses in these areas:
- Inventory report or supplier report (Cost Of Good Sold).
- Get packing supplies
- Salary expense (VAS) or contractor cost
- Shopify app costs
- Hosting and maintenance of websites
- Business Travel
- Business Meals
- Training and conference expenses
- Paid State or Local Tax
- Research and development expenses
- Rent an office or rent a home office
- Inventory loss or spoilage expense
- Vehicle Expense
To reduce your taxable revenue, track expenses.
You need to know that every dollar that you keep track of (and provide evidence through receipts/invoices) is another marginal tax dollar which can lower your taxable income.
An example of an ecom profit-and-loss statement might look like this:
(+) $2,304,231.22 Sales
(-) $799.923 COGS
(-) $400 321 Ad Spend
Email Marketing Software – (-) $3453
(-) $34,223 VAs and Staff
(-) $33,221 Stripe/Paypal Transaction Charges
$1.033,090.22 net profit/taxable income (Congratulations).
It’s not a terrible year, right? What if someone tells you they’re taking 40% of the Taxable Income amount.
You’ve worked hard to get here, and notmaximizing your deductions will force you to give up a lot of your hard work.
What if you could save 15%-25% on your bottom line?
You can! You can reduce your taxable income by tracking every dollar spent. It is why it is an essential step in establishing a profitable and successful ecom business.
The key point: Do not forget the importance of good bookkeeping. Every dollar that is accounted for means another marginal tax dollar in your pocket.
5 Ridiculously Easy Deductions to Shopify Taxes
Ok, so I tried to get through your head so far.
Tax Deduction = Dollar Dollar Bills!
Tax deductions are not going to let you down, abandon you, run around, leave you, make it difficult, make you sad, tell you a lie, or cause you any harm. Rick knew best.
The IRS also knows how much money is being left on the table every year. This statistic is taken from one of our course slides.
Don’t fall for these men and learn how to keep your hard-earned cash where it belongs: in a bank account.
We’ll use this opportunity to present the essential ecom deductions you must know in order to benefit from the IRS tax code.
Shopify Taxes #1: Advertising Expense
Every ecom company’s bread and butter is their management of paid advertising.
It doesn’t matter if you get 0.5 ROAS or 3 ROAS from your adset, they are BOTHtax-deductible.
Do not be afraid to include all advertising expenses on your Schedule C Form (more later).
An online business should expect to spend a lot of money on advertising. You won’t have to report too much on E-commerce marketing.
Tip – If you need to find your Facebook receipts, the instructions for downloading them can be found here.
Shopify Taxes #2: Merchant Fee
Merchant fees are often overlooked because they are usually subtracted by your payment processor inconspicuously.
However, $60,000 tax deduction is possible for a $2M company.
You should be able to access the financial portal of your payment processor and obtain an accurate Merchant Report.
Shopify Taxes #3: Home Office Deduction
“So, the question we received at our agency frequently this past year was, I am working remotely, what type of deductions are I allowed to take?”
There is good news: All business owners can take a deduction for their home office!
Two requirements are required to be eligible for the program:
- “Regular and exclusive usage” – This means that any space you use for work must be used only by business.
- It should be your principal business location.
There are two methods to get this deduction if you have met these requirements.
- Simple Option
- Actual Expense Method
Let’s go over each step a bit more.
As the name suggests, this simplified method is simple to claim:
Take the square footage you own and multiply it with $5 per square foot. That’s your tax deduction amount.
The simplified option has a limit of 300 square feet. This means that $1500 is the maximum you can take.
This method is recommended if you need to file a last-minute return.
You should however, compare it with the Actual Expense Method as this can result in a higher deduction amount.
Actual Expense Method
The actual expense method is more complicated. However, it allows you to fully deduct any direct expenses (such as painting or repairs in your home office).
Indirect expenses like mortgage interest, insurance and home utilities, as well as real estate taxes and general home repairs, are also exempted based on how much of your home is used for business.
So a real quick example:
Let’s suppose you were paid:
- $5,000 in mortgage interest
- $2,000 in insurance premiums
- $3,000 in utilities (all indirect costs)
- Additional $350 for a home office painting job (direct expense) during the year.
Your home office occupies 600 square feet of a 1,500-square foot home. You may be eligible to deduct indirect costs on up to 40% of your home.
You can take $1,500 off your taxes if you choose to use the simplified option.
The Actual Method however…
- 40% of home office income is from the home (600/1 500).
- Add the % to your total indirect expenses ($10,000 x 40).
- House painting costs $500 more than direct expenses
You can now take a $4350 deduction. This is a $2850 increase in your tax deduction.
Some of our clients have a larger operation at home and we were able to obtain $24,000 tax dollars by using this home office deduction.
What would you do for your eCom company?
Shopify Taxes #4: Startup Cost Deduction
IRS Publication 535, states that business owners may deduct $5,000 for startup costs during their first year.
What is it that qualifies for Startup Cost Deductions? These are the three major areas of Startup Cost.
- Preparing your Business to Open Examples: Travel to other countries to meet suppliers and pay consultant fees.
- Creating Trade or Business — Such as product research.
- Organizational Cost Examples: Legal fees and accounting fees, state filings, incorporation fees, insurance
You can take advantage of this “secret” deduction if you have incurred any of these expenses in your first year of business.
This is an unusual deduction that will give you extra confidence when you start your business in the new year.
Shopify Taxes #4: Bonus Depreciation
One of our clients said last winter that they were afraid to expand because of the tax implications.
They were unsure if they had enough cash flow to pay their taxes. We assured this client there was nothing to be afraid.
Small business owners have found the current post-pandemic climate very encouraging. Small business owners have received a lot of support and help from the government to expand their US businesses.
A powerful bonus depreciation is one example of this. As a way of encouraging small business investment, Congress established bonus depreciation.
Let’s look at how depreciation works in general.
The tax deduction for depreciation can be used to lower the asset’s value due to wear and tear.
The most common approach is a straight-line method. For example, if your asset has a $100k life expectancy, you can take $10,000 per year.
You can get a bonus amount of depreciation for the first year after you purchase the item.
You were able to take 50%, but the Tax Cut and Jobs Act has made that 100%.
Yes. The asset you have purchased in the last year can be written off completely.
These assets are eligible for Bonus Depreciation
- Equipment for manufacturing
- Heavy machinery
- Computer Software
- Qualified television and film productions
Not :Land, buildings and other properties do not qualify
There’s more. The new laws no longer require assets to be new in order to receive bonus depreciation. You can also buy assets that are already in use.
Here are some other amazing facts about bonus depreciation
- There is no annual cap on deductions
- It can be more than your annual business income.
- The asset must be in service by the year.
There is no better time to get bonus depreciation than right now!
eCommerce example of bonus depreciation
Adam, a manufacturer of fitness equipment, decided to create his own revolutionary weight-training equipment.
He bought machinery collectively valued at $1,000,000 and is currently in the 35% tax bracket. What tax savings could he get under Bonus Depreciation
Answer – For 1.5M of equipment, he is allowed to deduct all equipment under the current 100% bonus deduction ruling. This results in:
1,500,000 Tax Deduction + 35% Tax Bracket Ratio
Save $555,000 on your taxes
He was able to buy the 1.5M machine for $945,000, which is literally a 35% discount.
Adam now has more freedom knowing that his investments will provide the highest tax savings.
ProTip To learn more about money-saving tax deductions such as the one mentioned above, download our ebook – 9 Crucial ECOM Tax Deductions That The IRS Doesn’t Want You to Know – where you will find even more tax deductions that can make a difference for your ecom company!
Do You Need to Manage Your Shopify Taxes?
Our company is often asked questions like: When should I hire an accountant/CPA for my Shopify taxes? Or when is it better to handle it myself?
It is usually broken down into three levels.
- Annual Sales: From 0-100K
- Annual Sales: 250K to 500K
- Annual Sales of 1M+
Here are our top tips for every level of business development
Annual Sales: From 0-100K
You don’t have to hire anyone if you are between 0 and 100K in sales.
Your brand is just beginning to grow. At your current revenue level, there is no significant savings between hiring a professional and filing your Shopify tax returns yourself.
I would like to take this opportunity for your bookkeeping, tax planning and financial reporting. This will allow you to better understand the cash flow and financial position of your business.
This software is for you:
Bookkeeping software recommended:
- Quickbooks online is one of the most widely used bookkeeping programs. Although there is a learning curve, they offer a complete training program.
- Freshbooks has an intuitive interface for non-accountants. Although not as robust as QBO, it does the job at this level of revenue.
We recommend that you learn the IRS terminology and accounting lingo as you grow so you can easily navigate the tax and accounting worlds.
You might also find it useful to take our ‘ Tax Free Ecom Course_. It was designed for online entrepreneurs to help them feel more confident while saving a lot of money.
Reconvert users get a 20% discount if they are interested. To get the course, use code Reconvert-20
Sales from 250K to 500K
After you reach the 250K mark, it becomes easier to get a professional financial review.
Missing tax deductions or credits can have a significant impact on your bottom line, so I recommend that you at least get on a consultation call with a CPA in order to review all of your transactions.
An experienced tax accountant will be able to use an all-year approach that allows them to:
- Communicate better with clients about all tax planning recommendations throughout the calendar year.
- Use advanced strategies to make sure merchants use the sales tax threshold to their advantage in all states
- Keep track of the cash flow situation of merchants and examine their monthly trends in gross margin and breakeven ratio.
Sales of 1M+
After you reach the 1M+ mark you should immediately consult professionals to review your bookkeeping and shopify tax savings.
Once you have gotten past the 7-figure part, it becomes more likely that you will be subject to an IRS audit.
You’ll need to hire a qualified CPA to help you understand your business and ensure that your books are in order.
You could give away $50,000+ in Tax Savings if you aren’t optimized after you reach the 7 figure mark.
It is a terrible thing to give away money that you don’t need to someone else.
These are the 5 most important eCommerce tax forms to know
Forms and taxes go hand in hand. These are the most important Tax Forms that eCommerce business owners should know about:
- W9 tax form ( Link here ) – To comply with IRS contractor guidelines, if you’re looking to hire contractors to work for your company and pay them more than $600 per year in salary, have them complete a W9 form!
- 1099_MISC Form ( Link) The 1099 form is an annual file (due January of each year), in which you must declare the salary paid to each person (above $600 in rents, services or other income payments that are not W2 employees)
- Schedule A – ( link here ) This form is for sole proprietorships and LLCs and allows them to report business income and expenses. This form will help you understand the tax deductions that your business can claim to maximize your tax savings.
- Form 1099–K If your business accepts credit card payments, you will be issued a 1099K, Payment Card and Third Party Network Transactions form. This report reports the total amount of all reported payment transactions. Your bookkeeping must reflect your business income. The 1099-K, Payment Card and Third Party Network Transactions form is a third party “check-up”. This report reports the gross amount of all reported payment transactions for the year. This form is typically sent by Stripe, Paypal and Shopify Payments.
- Form8824 – ( link here). “Like-Kind Exchange”, a form that reports capital assets you have exchanged for another of the same nature, without creating a tax event, is essential. It is a great way to both defer taxes and dispose of assets simultaneously. You can exchange one ecom company for another.
Get forth and shopify tax savings!
We hope you have enjoyed this glimpse of the power of proper bookkeeping for Shopify taxes.
Our technology services : Magento POS, BigCommerce POS, Shopify POS, Woocommerce POS, Restaurant POS, NetSuite POS, Thailand POS, South Africa POS and Commercetools POS
This article will conclude with three key points you need to consider for your ecom company:
- So you don’t have to give your hard-earned money away, learn the tax credits and deductions that are important for your business.
- Tax planning is an ongoing event. Hire a CPA who understands your business. They will be available 365 days per year to answer any questions you may have.
- Get started early to learn about all the tax strategies and tax benefits that you can use to propel your business to the next level.
Keep this article in your bookmarks and let us know what you think about the importance of accounting and tax knowledge when scaling your business. We’d love to share your tax savings with ya!
We are excited to see you all take your brand and passion to the next level!
Article source: https://www.reconvert.io/blog/shopify-taxes/