Tax Strategy for Ecommerce Sellers

Multi-State Nexus After Wayfair

For fifty years, a state could require a seller to collect sales tax only if the seller had physical presence there, under Quill Corp. v. North Dakota. In June 2018 the Supreme Court overruled Quill in South Dakota v. Wayfair, Inc., holding that physical presence is not required and that a substantial economic connection is enough. Within two years, every state with a sales tax had enacted an economic nexus statute.

The typical threshold is $100,000 in gross sales into the state during the current or prior calendar year. California, Texas, and New York use higher figures, with New York at $500,000 and more than 100 transactions. A number of states originally paired the dollar threshold with a 200-transaction test and have since dropped the transaction count, because it swept in small sellers shipping low-value items. Whether the threshold is measured on gross sales, retail sales, or taxable sales varies by state, as does whether marketplace sales count toward it.

Physical presence still creates nexus independently, and this is where ecommerce sellers are most often surprised. Inventory stored in a third-party fulfillment center creates physical presence in that state under most state statutes. A seller enrolled in Fulfillment by Amazon whose units are distributed across warehouses in a dozen states has, on most states' reading, physical presence in each of them, without ever having chosen to be there. Remote employees, contractors soliciting sales, trade show attendance beyond a de minimis period, and drop-ship arrangements can all create presence as well.

Marketplace facilitator laws have substantially reduced the practical exposure. Every state with a sales tax now requires the marketplace, not the seller, to collect and remit on sales made through it. Amazon, Walmart, Etsy, and eBay collect on those transactions. What this does not cover is direct sales through your own Shopify or WooCommerce store, wholesale transactions, and sales through channels that are not facilitators. A hybrid seller doing $2,000,000 on Amazon and $400,000 through their own site is protected on the first number and fully exposed on the second, and the marketplace sales may still count toward the economic nexus threshold in states that include them.

Income tax nexus is a separate and broader question. Public Law 86-272 protects a seller from state income tax where its only activity is soliciting orders for tangible personal property that are approved and shipped from outside the state, but states have narrowed that protection aggressively, and the Multistate Tax Commission's revised guidance treats many routine website functions, including cookies that gather customer data and post-sale chat assistance, as activities that exceed mere solicitation. A seller can therefore owe income tax filings in states where the protection has been read away. We cover the analysis under multi-state and global tax.

Where a seller has been operating past a threshold without registering, the exposure includes uncollected tax, penalties, and interest, and there is no statute of limitations in most states until a return is filed. Voluntary disclosure agreements are available in nearly every state and typically limit the lookback to three or four years and waive penalties, which is almost always a better outcome than waiting for a notice.

Inventory Accounting and Cost of Goods Sold

Inventory is the largest number on most ecommerce returns and the one most often computed wrong. Cost of goods sold is opening inventory plus purchases less closing inventory, so any error in the closing figure moves taxable income dollar for dollar.

FIFO assumes the earliest units purchased are the first sold. It is the default for most sellers, it matches physical flow for anything with a shelf life or a model year, and it aligns book and tax reporting. In an inflationary period FIFO leaves the oldest, cheapest costs in cost of goods sold and the newest, most expensive costs in ending inventory, which produces higher taxable income and a higher balance sheet inventory value.

LIFO assumes the most recent purchases are sold first, which in an inflationary period pushes higher costs into cost of goods sold and defers tax. The deferral is real but it comes with conditions. IRC Section 472(c) imposes the LIFO conformity requirement: if you use LIFO for tax, you must use it in financial statements issued to lenders, investors, and owners. The election is made on Form 970 and is difficult to revoke without IRS consent. A LIFO reserve builds up over time and is recaptured when inventory is liquidated or the business is sold, which frequently lands in the same year as a large gain. And LIFO is not permitted under IFRS, which matters for sellers with foreign reporting obligations. For most ecommerce businesses the administrative cost and the recapture exposure outweigh the deferral, and we recommend FIFO unless there is a specific reason otherwise.

Specific identification is available and appropriate for high-value, serialized goods, and weighted average cost is used by many inventory systems and is acceptable if applied consistently.

Two provisions change the analysis for smaller sellers. Under IRC Section 471(c), a taxpayer meeting the gross receipts test, average annual gross receipts of $31,000,000 or less for 2025 measured over the prior three years, may treat inventory as non-incidental materials and supplies or may follow its applicable financial statement or books and records method. That is a genuine simplification and it lets many sellers deduct inventory when sold without full uniform capitalization. Above that threshold, IRC Section 263A requires that indirect costs including purchasing, handling, storage, and a portion of administrative overhead be capitalized into inventory rather than deducted currently, which increases taxable income and requires an annual computation.

Practical accuracy matters as much as method selection. Ending inventory must reflect a real count, not a system number that has drifted from reality through shrinkage, damage, and returns. Inventory in transit, units held at fulfillment centers, and returned goods awaiting disposition all belong in the count. Obsolete or unsalable inventory can be written down under Treasury Regulation 1.471-2(c) if it is offered for sale within 30 days at the reduced price or actually disposed of, and documenting that disposal is what makes the write-down hold.

1099-K Reporting and Reconciling Gross Receipts

Form 1099-K reports gross payment transactions processed by a payment settlement entity, which includes Amazon, Shopify Payments, PayPal, Stripe, Etsy, and every other processor an online seller uses.

The threshold has been unstable. IRC Section 6050W originally required reporting above $20,000 in gross payments and more than 200 transactions. The American Rescue Plan Act of 2021 lowered that to $600 with no transaction minimum. The IRS then delayed implementation repeatedly, announcing phased thresholds of $5,000 for 2024 and $2,500 for 2025 in Notice 2024-85. The One Big Beautiful Bill Act enacted in July 2025 repealed the lowered threshold and restored the original more-than-$20,000 and more-than-200-transaction test. Several states, including Maryland, Massachusetts, Vermont, Virginia, and New Jersey, impose their own lower thresholds that continue to apply regardless of the federal rule.

The threshold changes are noise for a real business. Income is reportable whether or not a form is issued, and any ecommerce seller of meaningful size receives forms in any case. What matters is the reconciliation, because the number on the 1099-K almost never equals the revenue on your return.

The 1099-K reports gross transaction volume: the full amount charged to the customer before marketplace fees, payment processing fees, refunds, chargebacks, shipping collected, and sales tax collected by the marketplace on your behalf. A seller with $1,000,000 on the 1099-K might report $1,000,000 of gross receipts and separately deduct $150,000 of marketplace fees, $30,000 of processing fees, and $60,000 of refunds and allowances. Reporting the net figure as gross receipts creates a mismatch against IRS records that generates a CP2000 notice even though the tax is correct.

The reconciliation gets harder with multiple processors and multiple channels, and harder still when the same sale touches two forms. We build a channel-by-channel reconciliation that ties each 1099-K to the platform settlement reports and then to the general ledger, and we keep it as a workpaper. When a notice arrives, and for high-volume sellers one eventually does, that schedule is the entire response.

When the S-Corp Election Fits an Online Seller

Ecommerce is often a good candidate for S-Corporation treatment, because the profit is frequently disproportionate to the owner's labor. A seller running a largely automated operation with fulfillment outsourced, advertising managed by a contractor, and product sourcing handled a few times a year is generating profit from capital, brand, and systems rather than from hours worked. That is exactly the profile where a modest reasonable compensation figure is defensible and the distribution share is large.

The threshold analysis is the same as for any business. Below roughly $80,000 of sustainable net profit, the payroll cost, the additional return, and state franchise minimums consume the savings. Above that, the split becomes worthwhile, and it scales. A seller with $350,000 of profit paying a defensible $110,000 salary avoids self-employment tax on $240,000, which is worth roughly $12,000 to $14,000 per year net of costs.

Ecommerce introduces some specific considerations. Inventory-heavy businesses carry basis complexity in an S-Corporation, and shareholder loans do not create basis the way partnership debt does, so a seller financing inventory with personal guarantees on a line of credit needs the loan structured as a direct shareholder loan to the corporation if the losses are to be deductible. Retail is not a specified service trade or business, so the Section 199A qualified business income deduction survives above the income thresholds subject to the wage and property limitation, which is an argument for keeping W-2 wages at a level that supports the 50%-of-wages test rather than minimizing them.

State registration multiplies with an S-Corporation. Where a seller already has income tax nexus in several states, an S-Corporation adds composite return or withholding obligations for nonresident shareholders in many of them, and some states, including New York City and Tennessee, do not fully respect S status. Those costs belong in the model before the election is filed. The full analysis is on our S-Corp election page.

The Recordkeeping That Makes All of It Work

Every strategy above depends on books that reconcile. Ecommerce accounting fails in predictable places, and fixing them at year end costs several times what maintaining them costs.

Settlement accounting. Marketplace deposits are net of fees, refunds, advertising, storage, and reserves. Recording the deposit as revenue understates both revenue and expenses, distorts margin, and breaks the 1099-K reconciliation. Each settlement should be broken into its components.

Inventory as an asset, not an expense. Inventory purchases are not deductible when paid. They enter cost of goods sold when the units sell. Sellers who expense purchases show wild swings in profit that track buying cycles rather than performance, and they overstate deductions in growth years.

Sales tax as a liability. Tax collected is held for the state, not earned. It belongs in a liability account and, for sellers with meaningful collection obligations, in a separate bank account.

Multi-currency and foreign supplier payments. Sellers sourcing overseas need consistent translation and need to watch for information reporting: Form 5472 for a foreign-owned single-member LLC, FinCEN Form 114 where foreign accounts exceed $10,000 in aggregate, and Form 1042-S withholding where payments to foreign persons are involved. Penalties on these forms start at $25,000 and are assessed without regard to whether tax was owed.

Quarterly estimates sized to reality. Ecommerce income is seasonal, and a fourth quarter that produces half the year's profit does not fit evenly divided estimated payments. The annualized income installment method described on our quarterly estimates page is usually the right approach.