Consumer spending has shifted even more heavily from brick-and-mortar to e-commerce during the coronavirus pandemic. Many retailers are pivoting to e-commerce shops for the first time, and established online retailers are experiencing sizable growth.
Businesses that are seeing the highest uptick are those selling “essentials” — including groceries, office supplies, health and beauty, housewares, home improvement, and some recreational items.
U.S. e-commerce jumped 49 percent in April, compared to the baseline period in early March before shelter-in-place restrictions went into effect, according to new data from Adobe’s Digital Economy Index. Online grocery helped drive the increase, with a 110 percent boost in daily sales between March and April.
Online sales are absorbing the offline retail economy. Consumers who rarely or never bought online are making tremendous shifts in their shopping behaviors, while those who already relied on e-commerce have doubled down.
Existing clients at my e-commerce accounting firm are reporting exceptionally high volumes of sales — including numbers that are equivalent to what we typically see in Q4 — the busiest shopping quarter of the year. This coincides with recent studies that are claiming 43 percent of e-commerce merchants are reporting increasing sales.
E-com businesses that are now facing an influx of sales have an amplified need for efficient tax planning. Starting now, they need to monitor changes in laws, and strategize with a professional.
However, when it comes to advanced tax planning, I typically see that many online retailers either wait until the last minute or don’t do it at all, resulting in business owners missing out on money-saving options.
Tax Planning Starts Now
To save on the amount of taxes your business must pay in the future, you must plan ahead. Reducing your 2021 tax burden happens through thoughtful steps in 2020, while you’re seeing an increased amount of sales.
First and foremost, as an e-com business owner, you have to understand why tax planning is so important. The most obvious reason is no doubt that you would be happy to pay less on your taxes overall. To do so, you need a solid plan in place, and such a plan can’t be strategized and executed in the short term.
Many tax plans require a lengthier amount of development time for effective implementation. Also, time is of the essence as many tax reduction strategies have a strict cut-off point. If your tax planning ideas aren’t in motion by Jan. 1, they’ll likely become pointless and serve you no benefit.
Another point that’s important to mention is that tax planning is not tax preparation. Tax filing is when you prepare and send in your tax return to the IRS to ensure you are paying your taxes legally and correctly.
Tax planning is to help make sure you are paying your responsible amount of taxes and not a dime more. The IRS issues billions of dollars in refunds every year because Americans mistakenly have overpaid what they owe in taxes. This can happen if you send in estimated tax payments that are higher than they need to be, or if you haven’t properly planned to take advantage of reductions.
It’s critical to work with a tax professional that specializes in the e-com industry to take advantage of a mix of accounting skills and e-commerce experience. An e-commerce CPA can closely observe your business and learn the ins and outs, and help strategize a business restructuring plan that will save you money on taxes.
The plan has to be personalized and designed in advance to be effective. The steps you take now — before the end of the tax year — are the most crucial to helping your business save money when you file your 2020 taxes.
Whether your sales are seeing an uptick because of COVID, or because of other circumstances, I strongly suggest putting tax planning at the top of your to-do list. Failing to properly manage your taxes might end up getting your business charged with IRS penalties and interest, or leave you with hefty tax payments. Knowing how to minimize the amount of taxes you pay means that you might get to keep more of the money you earn during this high-growth period.
Stay Up to Date on Current Legislation
When tax planning, a good place to start is to see if your business can benefit from any new legislation, IRS rulings or court cases. Tax laws are changing constantly.
The combined number of new and changed sales and use tax rates since 2010 is 5,733, an average of 521 per year, according to the Vertex 2019 end of year report. While it may seem like a daunting task to stay up to date on legislation, sometimes tax changes have positive impacts and benefits for e-commerce businesses.
Right now, many small businesses are taking financial losses because of COVID, and the Treasury Department and the Internal Revenue Service launched the Employee Retention Credit as a result.
For example, currently for qualifying e-commerce companies, 50 percent of the first US$10,000 in sales is tax-deductible as long as you can prove that your company has been affected by the virus. E-com businesses are eligible for this credit for all employees as long as your company has fewer than 100 employees.
More than 40 states last fall followed through on previously announced plans to tweak their sales tax laws. The changes affected remote sellers (out-of-state sellers) and required them to charge sales tax subject to specific criteria in many states.
However, the coronavirus pandemic has led to stalled legislative sessions and delayed tax filing deadlines. Specifically, the halt of sessions put simplification bills in Colorado and Louisiana in limbo; Idaho and Kentucky have paused audits; and remote sales bills in Kansas and Missouri are uncertain.
With the way sales tax works, business owners collect sales tax from customers and remit that sales tax to the respective state on a monthly or quarterly basis. Many e-commerce business owners can hang on to the sales tax cash and defer the tax payments into the state. This is currently happening in California.
The California Department of Tax and Fee Administration (CDTFA) will allow small businesses with less than $5 million in annual taxable sales to defer payment on up to $50,000 of sales/use tax, and such deferrals will be interest-free.
Strategize How to Reduce Your Tax Burden
The first step I typically recommend to my e-commerce clients is to become an S corporation (S-Corp). An S-Corp, for United States federal income tax, is a closely held corporation that makes a valid election to be taxed under Subchapter S of Chapter 1 of the Internal Revenue Code. What this means for your business is that electing as an S-Corp can save you up to 15.3 percent on your tax bill if implemented correctly.
What’s great about this strategy is that if you have an LLC you can file an election with the IRS to request to be treated as an S-Corp for tax purposes even though you still have an LLC for legal purposes.
E-commerce businesses also need a firm understanding of what they are eligible to claim as a tax deduction. You’ll want to be keeping track of all of your expenses now so that you can claim these deductions when the 2021 tax season rolls around.
It’s important to be sure to keep documentation for each deductible business expense throughout the year. This includes your Internet, cellphone, software services, office supplies, travel costs and more. Additionally, the IRS offers a home office tax deduction to e-com businesses that are run out of the home, if select criteria are met.
Another common and immediate way to save on taxes is to contribute to a retirement plan. For many retirement plans, such as traditional IRA and traditional 401(k), contributions are 100 percent tax-deductible. Additionally, payments made after the close of the year can be deducted as long as the contribution is made before April 15 each year. For example, a contribution made on March 15, 2020, can be deducted on the 2019 tax return that’s due on April 15, 2020.
Adopting an “Accountable Plan” is also a suitable tactic. This is an IRS-approved reimbursement program that allows a business to reimburse employees for business expenses they incur as part of their work, which could include you as a business owner if you are also an employee of your business entity.
If an Accountable Plan is set up, then you can deduct those reimbursed amounts as if the business had incurred the initial expense itself. Accountable Plans also allow people who work from home the ability to deduct rent, cellphone expenses, car expenses and many other items.
Tax planning is an important part of owning an e-com business. With the uptick in sales that you currently might be experiencing, now is the ideal time to strategize to make sure you’re in the best possible position for the 2021 tax season.
You don’t have to go through the daunting task of tax planning alone. Working with a professional that specializes in e-commerce tax services, accounting and business structuring can make the process much easier for you, and ultimately save you money when it’s time to file your taxes next year.