Shopify Sales Tax Setup: Avoid Penalties with This Guide

Handling Shopify sales tax can be confusing, with different rules across states and countries. If you’re selling in the U.S., Canada, Europe, or Australia, understanding sales tax, VAT, and GST is essential to stay compliant. In this guide, Nextsky will help you navigate Shopify tax and reporting so you can collect taxes correctly and avoid penalties. Let’s dive in!

What is sales tax, and when do you need to collect it?

Sales tax is a tax that buyers pay when purchasing goods or services. Sellers collect this tax and remit it to the government as required. In the U.S., most states impose sales tax, except for five states: Alaska, Delaware, Montana, New Hampshire, and Oregon.

However, you only need to collect and remit sales tax if your business has a significant presence in a state, such as an office, warehouse, employees, or sales exceeding a specific threshold, known as a "tax nexus." Some items may be exempt from tax or subject to different tax rates depending on state regulations.

Types of special consumption taxes

Sales tax (United States)

In the United States, sales tax is a common consumption tax that varies by state. If you operate a business on Shopify, compliance with state-specific tax regulations is mandatory:

• Some states do not impose sales tax, including Alaska, Delaware, Montana, New Hampshire, and Oregon.
• Tax rates vary by jurisdiction, not only by state but also potentially including additional city or county taxes.
• Certain goods and services may be exempt or subject to reduced tax rates, depending on local regulations.
• Under the economic nexus rule, if your revenue or transaction volume in a state exceeds the defined threshold, you must collect and remit sales tax in that state, even without a physical presence there. For example, selling tea online across different states may involve varying tax rates and obligations.

Value-added tax (VAT – Europe)

VAT is a multi-stage consumption tax where the end consumer bears the full cost. If you sell to customers in the European Union (EU), consider the following:

• Businesses must register for VAT if their revenue exceeds the threshold set by the country where they operate.
• With the One-Stop Shop (OSS) model, VAT for cross-border transactions within the EU is calculated based on the buyer’s location, simplifying tax reporting for e-commerce businesses.

Goods and services tax (GST – Canada and Australia)

GST is a consumption tax similar to VAT, applied at a fixed rate:

• In Canada, federal GST applies nationwide. Additionally, some provinces impose a provincial sales tax (PST) or a harmonized sales tax (HST).
• In Australia, if your annual revenue exceeds AUD 75,000, you must register and apply a 10% GST to all orders.

Guide to calculating sales tax on Shopify for beginners

Calculating and collecting sales tax is critical to running an online business, especially on platforms like Shopify. Here are six steps to help you comply with regulations and avoid tax-related issues.

1. Determine where you have a tax nexus

The first step to sales tax compliance is identifying which states require you to collect and remit taxes. This is a "nexus," or a tax connection between your business and a state. There are two main types of nexus you need to understand:

• Physical nexus: Occurs when you have an office, warehouse, employees, or store inventory in a state.
• Economic nexus: Even without a physical presence, you may be required to collect taxes if your sales or order volume in a state exceeds a certain threshold (e.g., $100,000 in revenue or 200 transactions per year in Illinois).

Go to Settings > Taxes and Duties > United States in Shopify to check. The platform automatically analyzes your sales data and suggests states where you may have a nexus, ensuring you don't miss any critical tax obligations.

2. Check if your products are taxable

Not all products are subject to sales tax. Depending on the product type and state regulations, some items may be exempted or subject to preferential tax rates.

• Tax-exempt items include services, digital software, music downloads, fresh food, pharmaceuticals, etc.
• Taxable items include clothing, accessories, tangible goods, etc.

Shopify Tax can automatically categorize and apply the appropriate tax based on product type and customer location. Your role is to review and confirm, as the system is optimized for accurate and efficient tax compliance.

3. Register for a sales tax permit in nexus states

Before legally collecting customer taxes, you must register for a sales tax permit with the tax authority in each state where you have a nexus. The process is usually straightforward, with some states offering free registration, while others charge a small fee ranging from $10 to $100. Upon completion, you'll receive specific details from the state, including:

• Frequency of tax filing and payment (monthly, quarterly, or annually)
• Methods and deadlines for submitting tax returns

4. Set up sales tax collection on Shopify

After obtaining your sales tax permits, the next step is configuring tax collection on your Shopify store. Here's how:

• Go to Settings > Taxes and Duties > United States.
• You have two options:
  • Shopify Tax: Automatically calculates taxes based on product type and shipping address—ideal for saving time and avoiding errors.
  • Manual setup: If you have specific requirements or need to comply with unique regulations, you can manually input tax rates for each state.

If you sell on multiple platforms like your website, Facebook, TikTok, etc., ensure your system collects the correct taxes for all states where you have a nexus.

5. Prepare sales tax reports

When filing taxes, you must know how much you've collected in each state, county, or city. Shopify Tax provides detailed reports, including:

• Taxable and non-taxable revenue
• Local tax rates
• Report codes aligned with each state's requirements

You can filter data by period or destination or export it for auditing or reconciliation.

6. File tax returns on time

After collecting and tracking sales tax, filing tax returns on time for each state or region where you have tax obligations is critical.

• File even with no sales: Some states require a "zero return" to confirm your business is active and compliant, even if you had no sales.
• Late filings = penalties: Late submissions can result in fines, late fees, or even suspension of your sales tax permit, which can significantly impact your business.
• Tax discounts: Many U.S. states offer tax relief programs for businesses that file on time, such as refunds on a portion of collected taxes. This is a legal way to save costs that not everyone knows about.

Overview of sales tax rates by state

Sales tax rates in the U.S. vary by state, ranging from 2.9% to 7.25% (as of 2024). Below are some notable rates:

• 7.25%: California
• 7%: Indiana, Mississippi, Rhode Island, Tennessee
• 6–6.875%: Minnesota, Nevada, New Jersey, Kansas, Washington, Illinois, Massachusetts, Texas
• 5–5.75%: Ohio, Arizona, Virginia, Maine, Nebraska, North Dakota, Wisconsin
• 4–4.85%: Utah, Oklahoma, Louisiana, South Dakota, New York, Hawaii, Alabama, Wyoming, Georgia
• 2.9%: Colorado
• 0% (no sales tax): Montana, Delaware, New Hampshire, Oregon, Alaska

Note on local taxes

In addition to state-level taxes, many areas impose additional local taxes. For example, Louisiana has a state tax rate of 4.45%, but in New Orleans, you'd need to collect an extra 5% local tax, bringing the total tax rate to 9.45%.

How to add taxes on Shopify

Step 1: Determine Where You Need to Collect Taxes

Your tax obligations depend on tax nexus — physical (office, warehouse, employees) or economic (sales volume). Identify states/countries where you must collect tax.

Step 2: Register for a Sales Tax Permit (If Required)

If required, apply for a Sales Tax Permit in the relevant states or countries before collecting taxes.

Step 3: Set Up Taxes in Shopify

• Go to Settings → Taxes and duties in your Shopify Admin.
• Add tax regions (states, countries).
• Choose automatic or manual tax collection settings.

Step 4: Check product tax settings

• Go to Products in Shopify Admin.
• Select a product → Under Pricing, check Charge tax on this variant if applicable.

Step 5: Monitor and Report Taxes

• Download tax reports (Analytics → Reports → Sales tax report).
• File and pay taxes according to local regulations.

💡 Note:

• Shopify calculates but does not remit taxes—you must submit them yourself.
• International sales may require VAT/GST collection.

=>> Read more: How to add taxes on Shopify (Include taxes in product prices)