By filing your Shopify store taxes properly you could reduce your tax liability every year. We will show you how to fill out your Shopify Schedule C, calculate COGS, make deductions, and apply tax strategies that have the potential to cut your tax bill by 10-15%.
In this article:
- What documents do I need to file Shopify store taxes?
- Reconciling Shopify income
- Calculating Shopify COGS for Schedule C
- Shopify store tax write-offs
- What can I write-off for Shopify dropshipping taxes?
- How to drastically reduce my Shopify taxes?
Filing Shopify Store Taxes
Shopify store taxes are part of being a Shopify owner. Every year you should be setting aside at least 30% for your total tax liability. How much you actually pay will depend on your business entity, and write-offs.
Shopify Schedule C
For self-employed Shopify store owners, there is a good chance you will be filing income on a Schedule C. This form accompanies Form 1040, and describes your shop’s earnings in totality by listing expenses against profit.
Which Business Entities File A Shopify Schedule C?
- Sole Proprietors
- Single-Member LLCs
In order to maximize savings on your Shopify income taxes, you will need to gather a few items to fill out your Schedule C:
- Shopify 1099-K: If your store is performing more than 200 transactions or $20,000 in sales, you get a 1099-K that reports your Shopify income. You can find this in Shopify Documents, available after January 31st.
- Paypal 1099-K: You get a 1099-K from Paypal if you performed more than 200 transactions or $20,000 in sales. You can find this in the Statements and Tax area of your Paypal account.
- Shopify Finance Summary Reports: These are reports in your Shopify account where you access your sales, discounts, refunds, gift cards, and COGS figures.
- Shopify COGS report: This is found in the Gross Profits section of your Shopify Finances summary. It will only report product costs if you have entered a cost per item in your listings.
The reports in your Shopify Finance summary section are helpful if you didn’t receive a Shopify 1099-K. They are also needed for those that do receive one, to reconcile the figures shown on the 1099-K.
Note: Even if you don’t get a 1099-K you still need to report income. Shopify is sending your store earnings to the IRS.
Reconciling Shopify Income
Your tax forms should always match your 1099-K. However, the Shopify 1099-K will only show the income you made from Shopify payments. It does NOT include payments customers made using other merchant gateways. There will be a discrepancy between what Shopify reported on your 1099-K and your actual income for the year. To accurately report your income, make sure to include all 1099’s from your other merchant providers.
If you didn’t receive any 1099’s, not a problem. You can go into your Shopify sales reports and use your gross sales as a starting point for your Shopify store taxes. The gross sales figure represents everything you earned before discounts, returns, tax, and shipping deductions. On your Schedule C make sure you account for those items otherwise you will report more income and inevitably pay more taxes.
Shopify Income Tax Write-Offs
Your Shopify store has necessary expenses for business—*cough* inventory! Staying on top of the minutiae of your store gives you an accurate report of income on your annual tax return. Let’s go through where to focus your energy when making deductions on your Shopify Schedule C.
Shopify COGS
Shopify COGS accounting is vital for tax savings. The cost to sell inventory, or cost of goods sold (COGS) is the #1 Shopify expense. But, COGS has many different components, and aggregating them gets complicated. The best way to perform COGS accounting for Shopify is with an inventory management system. It will help you categorize and track each component of your inventory.
Cost Per Item In Shopify
When you start selling on Shopify, inventory management software may not be within the budget. So, you need to leverage Shopify’s system by calculating, entering, and constantly updating your total cost per item. Any products sold, that have a cost per item entry, will be reported on your Shopify COGS report.
Cost per item in Shopify is essentially your Cost of Goods Sold (COGS). It is the total cost of your product, and it helps you determine your profit margins per SKU.
Your products are a work-in-progress. Beyond the price of parts and manufacturing, any money that goes into your product before it goes live is considered in Cost per Item:
- Shipping, handling, or customs fees to get to the warehouse
- Packaging for product display (NOT customer shipping/packaging materials that goes in the expense section)
- Resale costs, labor, and assembly
- Ordering and procurement costs
- Factory Costs: like excess materials in manufacturing
- Storage Costs: warehouse fees, damage, theft, deadstock, obsolescence, etc.
Once you have formulated this number, make a Cost per Item entry in your Shopify product listings. Remember, the Shopify cost per item feature will accurately track your costs as long as you are updating when there are changes.
Note: Your Shopify COGS report will only show a lump sum with cost per item. You need to do proper accounting and break down your costs, to easily itemize COGS on a Shopify Schedule C.
Accounting For Shopify
You should have a bonafide accounting system for Shopify. Something that allows you to manage COGS and inventory account balances, as you make sales. We cannot stress this enough—accounting needs to happen continuously throughout the year, even if you don’t have an inventory management system. That way, during tax season you can easily reconcile your Shopify COGS report to your accounts, and calculate precise COGS.
Calculating COGS For Shopify Store Taxes
Reporting inventory expenses for your Shopify income taxes requires some math. So grab your Shopify COGS report, and break out the calculator for the COGS master formula.
COGS = Beginning Inventory + Purchase – Ending Inventory
The three values essential for the COGS formula are: Beginning Inventory, Purchases, and Ending Inventory. Here is a short description of how to arrive at each figure:
Beginning inventory
This is the value of the inventory at the start of the year. It will be the same as your Ending Inventory from the previous year or zero if you launched your store at the beginning of the year.
Purchases
These are all the fulfillments you made throughout the year. Depending on your inventory cost method this is the most difficult value to find for COGS calculations. With a cost method, you have to consistently account for fluctuations like varying supplier costs or multiple shipments throughout the year. We always recommend using the Average Cost Method (AVCO), it takes a simple average of your purchase price.
For Example: your screen printing business purchased cotton t-shirts for $6/shirt in a May fulfillment. In October, there was a supply chain disruption and the price jumped to $10/shirt. The average cost of your cotton tees was $8/shirt. Use that to figure as one of your expenses for your screen-printed t-shirts.
Unless you have a large inventory or a special circumstance, most Shopify stores do not need the FIFO or LIFO cost methods. They are advanced and should be performed by an accountant.
Ending Inventory
This is the value of inventory you have left to sell. You can find this number by performing an end-of-the-year inventory count. Reconcile your inventory account balance by comparing the stock levels you physically count. If you have inventory management software, it will track your stock levels. You can use this system as your source of truth or perform an annual physical count as well.
Filling Out Cost of Goods Sold On Schedule C Part III
Once you have the three values above you are ready to fill out Part III of your Schedule C. Here is a line-by-line guide to filing COGS expenses for your Shopify store taxes.
Line 33
Check “Cost” for AVCO, FIFO, or LIFO cost methods.
Line 34
This is where you inform the IRS of any inventory accounting changes. It is intended for a cost method change, which would need to be filed using Form 3115 in the year of change.
Line 35: Beginning Inventory
Indicate your inventory on hand at the beginning of the tax year. Line 41 Ending Inventory, from last year’s tax return, should match your beginning inventory of this year. If this is your first year reporting Shopify store taxes it equals zero.
You need to explain if there are any discrepancies between last year’s and this year’s numbers. Discrepancies occur with accounting method changes and will be considered by the IRS, in a section 481(a) adjustment with Form 3115.
Line 36: Purchases
Enter the total amount of inventory purchased less any product that was comp’d for personal reasons.
Line 37: Cost of Labor
The total wages paid to workers manufacturing the products.
Line 38: Materials and Supplies
These costs include all parts for assembly, raw materials, factory costs, display packaging, and any other items purchased for resale and/or to create the product.
Line 39: Other Costs
This is the “everything-else-that-supports-production” category: ordering, procurement and admin costs, inventory software, utilities used to produce the product, storage, shipping to the warehouse, handling, or customs fees.
Line 41: Ending Inventory
The dollar value of inventory on-hand at the end of the year, including unused raw materials.
Line 42 Cost of Goods Sold
The figure for this line is the same number that goes in Cost of Goods Sold on Part I, Line 4 of your Schedule C.
Shopify Store Tax Write-Offs: Schedule C Part II
Phew! COGS is out of the way, let’s maximize savings with other Shopify deductions. When doing your annual taxes make sure to itemize:
- Shopify subscription and app fees
- Payment processing fees
- Web hosting and domain fees
- Online advertising
- Packaging and shipping to the customer
- Equipment used for business: phone, computer, tablet
- Internet and software subscriptions
- Office supplies
- Any travel expenses
What Can I Write-Off For Shopify Dropshipping Taxes?
Shopify drop shippers do not have COGS expenses. Since you are getting a cut for selling the products, the arrangement is much like a salesman working on commissions. Of course, you still deduct expenses, but since you are not directly working with inventory, the COGS section does not apply to you. Instead, you report drop shipping expense deductions exclusively in Part II of your Schedule C.
In addition to some of the deductions in the previous section, here are common Shopify dropshipping tax write-offs:
- Marketing tools & subscriptions
- Advertising campaigns
- Admin costs for accountants, developers, and personal assistants
- Home office
- License and business fees
How Do I Drastically Reduce My Shopify Tax Bill?
Is your tax bill hitting 5 digits? You should graduate from filing income on a Schedule C. Relying on year-to-year credits and deductions for savings is not a tax plan. There are ways to drastically reduce your Shopify store taxes by changing your business entity.
Setting up the right business entity for your Shopify store can cut your SE tax in half. You should be an incorporated LLC or C Corp, then apply for an election to become an S Corporation. The benefit is that S Corporations owners are only charged 7.65% SE tax on income that is wages. The business itself does not get charged the other half of SE tax, because it is a pass-through business entity to its owners.
Note: you need to pay yourself a reasonable salary as the owner of your business.
Making an S election is one part of the recipe. You can also reduce your state income tax liability by registering your eCommerce business in a state that charges no income tax. Save money at the state and Federal levels, by registering your business in a state that has no income tax AND recognizes your S election.
Watch out! Two no income tax states do NOT recognize the Federal S election: Tennessee and New Hampshire. They will tax your business as if you are a C corporation.
Shopify Store Taxes Are Done
Dust your shoulders off because you just finalized your Shopify store taxes for the year. Keep up the good housekeeping in your accounting. Tax planning for your store happens throughout the year, NOT just during tax season. Right out of the gate, you need to be calculating COGs accurately for each product. Knowing your product costs will help you work towards increasing your profit margins.
