Note: This article is meant as a reference for sellers doing preliminary research for their Shopify business. It isn’t meant as any form of legal advice, and should not be used as a replacement for such. Please consult a professional accountant for your business and if you have questions.
Collecting sales tax has become a confusing issue for many online retailers over the past year, with recent changes to when and how online retailers charge and remit sales tax. To help, we’ve put together a beginner’s guide to Shopify sales tax, and how you can use the platform to efficiently and correctly comply with local tax laws.
Online sales tax – an introduction
Before we look at how to collect tax through your Shopify store, let’s first cover the basics of online sales tax.
Before 2018, online retailers were only required to charge and remit sales tax in the state that they had a physical presence. This allowed many online sellers to lower their prices when selling across different sales tax jurisdictions in the US because they avoided the requirement to charge tax.
However, the case of South Dakota v. Wayfair in 2018 changed things dramatically. Instead of requiring online retailers to have a physical presence (known as nexus) in a state before becoming responsible for sales tax, you now only require an economic presence.
For example, if you sell more than $100,000 or 200 transactions per year to customers in a particular state you must register for a sales tax permit, and you become liable for charging and remitting sales tax in that state.
Tip: To learn more about Nexus, check out Avalara’s guide to Nexus laws by state.
To make things even more complicated, this economic threshold differs between states, as does the registration requirements, and remit frequency. In addition, the method used to calculate the tax due also differs between one of the following:
- Destination-based – calculated based on where your customer is located.
- Origin-based – calculated based on where you’re located.
Confused? It’s not surprising. Tax laws and regulations are not only complex, but they’re also frequently changing. However, by setting up Shopify to handle your sales taxes, you can simplify the process and ensure ongoing compliance.
Setting up taxes for your Shopify store
There are five main steps for setting your store up for Shopify sales tax. These are:
1. Select your store address
First, you must correctly add your store address to Shopify so that local and remote sales taxes are applied correctly. From the Shopify admin, go to Settings > General and enter your correct physical store address.
2. Create shipping zones
Next, you must select the different regions that you ship to. Since different states have different tax rules, you want to create a shipping zone for each jurisdiction.
To add shipping zones from your Shopify admin, click Settings > Shipping. Under the shipping zones section, click Add shipping zone, and then give the zone a name and select the regions you want in that zone. Once finished, click Done.
3. Set up automatic tax rates for physical nexus
Next, you need to set up Shopify to automatically calculate the tax rates for the shipping zones located in your physical nexus. To do this, go to Settings > Taxes and complete the following sections.
Select whether taxes are included in your prices and if you want to apply taxes to your shipping rates. If you have presence in states with different rules on shipping rate taxation, you can set up a manual override once you have completed the tax rates section below.
Select the United States and tick the box to enable automatic tax calculation. Under Country, municipal, and state taxes section, add all the states that you have a physical presence in, along with the zip codes. For example, an office, warehouse, or other facilities.
4. Set up automatic tax rates for economic nexus
Shopify isn’t yet fully optimized for automatically calculating economic nexus tax rates. However, there is an approved workaround that you can follow.
If a flat-rate tax rate applies, you can add a physical presence of any ZIP code for that state and then add a tax override for the appropriate products.
If a destination-rate tax rate applies, you can add a physical presence of any ZIP code for that state only. You do not need to add an override.
5. Set tax exemptions or overrides
There may be instances where you want to calculate sales tax manually or add an override. For example, if you sell items that are exempt from tax or have a presence in states with different shipping tax rules.
To set up a tax exemption, first, create a product collection of the applicable items by clicking Products > Collections > Create Collection. Next, add the tax exemption by going to Settings > Taxes > Country > Tax overrides and choosing the collection or location from the drop-down menu and adding the relevant location and rate.
It’s crucially important that you keep these settings under review to ensure that any changes in the law are accurately reflected.
Processing taxes for your Shopify store
While Shopify can help to apply the right tax rates to your products, it doesn’t file or remit sales taxes for you. However, the following can help.
Shopify tax reports
To help with your sales tax reporting, you can download a taxes finance report and a sales finance report to collate information on order amounts, taxes, POS, billing, and shipping locations. This can then be used to complete your tax returns.
There are some Shopify-integrated plugins like TaxJar and Quaderno that can assist with detailed reporting, automated filing, and invoicing to simplify your returns process. If you’re selling via Shopify Plus, you also have access to Avalara, which is more powerful than Shopify’s in-built tax features.
Tax is a fiddly area of online selling, and if you make a mistake it can have costly consequences. If you’re struggling to get your head around the latest legal changes and how to set you Shopify taxes up successfully, enlist the help of an eCommerce accountant or bookkeeper. They could save you serious money in the long run.
Tax can be taxing, but by being proactive in updating your knowledge and setting up your Shopify store correctly, you can be compliant and grow your cross-jurisdiction online business with confidence.