Does Tax Free Work Online for Purchases or Income?
Navigate the complexities of online taxation. Discover how your digital transactions and income are generally subject to various tax rules.
Many believe online activities, whether purchasing goods or earning income, are tax-free. However, both online purchases and income generated digitally are generally subject to various taxes.
Sales Tax on Online Purchases
Sales tax is a consumption tax on goods and services. Historically, online purchases often avoided sales tax collection if the seller lacked a physical presence, or “nexus,” in the buyer’s state.
The landscape changed following the 2018 Supreme Court decision in South Dakota v. Wayfair, Inc.. This ruling overturned the physical presence rule, allowing states to require out-of-state sellers to collect sales tax based on their economic activity within a state, known as “economic nexus.” Economic nexus thresholds involve a certain volume of sales revenue or number of transactions into a state annually. Nearly all states with a sales tax have enacted economic nexus laws, requiring remote sellers to collect and remit sales tax.
Another significant development is the widespread adoption of “marketplace facilitator” laws. These laws require large online marketplaces like Amazon, Etsy, and eBay to collect and remit sales tax on behalf of the third-party sellers using their platforms. This shifts the tax collection responsibility from individual sellers to the marketplace itself, simplifying compliance for many small online businesses. However, sellers remain responsible for sales tax on sales made outside these facilitated marketplaces, such as through their own websites.
The sales tax rate applied to an online purchase is determined by the buyer’s location, known as destination-based sales tax sourcing. This means the sales tax collected includes state, county, and city sales taxes applicable to the delivery address. While most goods are subject to sales tax, certain items or services may be exempt depending on state law, such as groceries or prescription drugs.
Tax Obligations for Online Income
All income earned is taxable, including that from online activities. Whether from online freelancing, e-commerce, content creation, or gig economy work, it is subject to federal income tax. Individuals operating online as independent contractors or business owners earn “self-employment income.”
Self-employment income is subject to self-employment tax, covering Social Security and Medicare taxes for self-employed individuals. The self-employment tax rate is 15.3% on net earnings, consisting of 12.4% for Social Security and 2.9% for Medicare. The Social Security portion applies to net earnings up to a certain annual limit, while the Medicare portion applies to all net earnings.
Online income earners may receive various reporting forms. Form 1099-K is issued by payment processors and online marketplaces for transactions related to goods and services, typically above a certain threshold. Form 1099-NEC is used to report payments of $600 or more for services performed by non-employees. Even if a 1099 form is not received, all income is still taxable and must be reported on a tax return.
Individuals earning online income can reduce their taxable income by claiming various business expenses. Deductible expenses for online work include a portion of home office costs if the space is used regularly and exclusively for business, internet and phone bills, software subscriptions, and advertising costs. Keeping detailed records of all income and expenses is important for accurate tax reporting.
Important Considerations for Online Tax Compliance
Online activities are generally subject to taxation. While some states may not have a state income tax or state sales tax, federal taxes on income still apply, and sales tax may still be due based on economic nexus rules.
Maintaining accurate records is important for tax compliance. For online income earners, diligent record-keeping of earnings and deductible expenses is necessary for accurate tax reporting and to support deductions claimed. This documentation is also important in the event of an audit.
Failure to comply with tax obligations for online income can result in penalties and interest charges. The IRS may impose accuracy-related penalties for reasons such as negligence or a substantial understatement of income. For complex situations involving online business structures or significant income, consulting with a tax professional can provide personalized guidance and help ensure compliance.