Income tax is a different system than sales tax

It's easy to conflate the two, but they're unrelated obligations: sales tax (see Sales Tax Nexus, Explained) is collected from customers and remitted to states on taxable sales. Income tax is what you owe — to the IRS and typically your state — on your business's actual profit, regardless of where your customers are located. A marketplace facilitator law can eliminate most of your sales tax collection work; nothing eliminates your income tax obligation on profit.

The core categories worth tracking through the year

Waiting until tax season to reconstruct a year of business activity is the single biggest cause of an inaccurate return (or an expensive number of hours paying a preparer to do reconstruction work you could have avoided). Track these categories as you go, ideally through dedicated business banking and bookkeeping software rather than mentally or via a personal account:

  • Gross sales revenue, by channel/marketplace, reconciled against 1099-Ks and platform settlement reports (see Understanding 1099-K Reporting).
  • Cost of goods sold (COGS) — what you paid for the inventory you actually sold during the year, which is different from what you purchased during the year if your inventory levels changed.
  • Marketplace and payment processing fees — referral/commission fees, fulfillment fees, payment processing fees; these are deductible business expenses, not something to net out informally.
  • Advertising spend — marketplace ad platforms and any other paid marketing.
  • Shipping and packaging costs not already included in COGS or marketplace fulfillment fees.
  • Software and subscriptions — accounting software, inventory tools, design tools, apps.
  • Business use of home office, if applicable, following the specific rules for that deduction rather than an estimate.
  • Contractor and employee payments, tracked separately since they carry their own reporting requirements (1099-NEC for contractors above the applicable threshold, payroll tax filings for employees).
  • Business insurance, professional fees (legal, accounting), and any other genuine business expense.

Why the distinction between cash and accrual matters here

How and when you recognize revenue and expenses depends on your accounting method (see Bookkeeping Basics for Ecommerce Sellers for the cash-vs-accrual comparison) — this affects which tax year a given sale or expense lands in, which matters most around year-end.

Estimated quarterly taxes

Unlike a W-2 employee who has tax withheld from every paycheck, a self-employed seller or business owner is generally expected to pay estimated income tax (and, depending on business structure, self-employment tax) quarterly rather than as a single payment at filing time. Underpaying through the year can result in a penalty even if the full amount is paid by the annual filing deadline. If your ecommerce income is your primary income or growing quickly, estimated payments are one of the first things worth setting up (or confirming your accountant has set up) rather than treating as optional.

Business structure affects what you're tracking and filing

A sole proprietor generally reports business income and expenses on a Schedule C attached to their personal return. An LLC taxed as a sole proprietorship works similarly; an LLC or corporation taxed differently (S-corp election, C-corp) has materially different filing requirements, payroll considerations (an S-corp owner often needs to run "reasonable compensation" through payroll), and tax treatment. If you're not certain which category you're in or whether your current structure is still the right one at your revenue level, that's worth a specific conversation with a tax professional — the right structure at $50k in revenue is not always the right structure at $500k.

A simple year-round system

  1. Use a dedicated business bank account and card — mixing personal and business transactions is the single most common cause of a painful reconstruction project at tax time.
  2. Reconcile your books monthly, not annually — categorize every transaction into the categories above as it happens, or at least monthly, rather than in a year-end batch.
  3. Set aside a percentage of profit for taxes as you go, in a separate savings account, so quarterly estimated payments (and the eventual filing-time balance) don't come as a cash-flow surprise.
  4. Keep receipts and documentation for every deductible expense, ideally digitized, in case of an audit.
  5. Review your numbers quarterly with your accountant (or on your own, if you're not yet working with one) rather than only at year-end — this catches structural issues (like a missed estimated payment or a business-structure question) while there's still time to act.

Common mistakes

  • Mixing personal and business spending in one account, making expense categorization a forensic exercise later.
  • Treating all inventory purchases as an immediate expense rather than correctly matching COGS to units actually sold.
  • Skipping estimated quarterly payments and getting hit with an underpayment penalty even though the full tax was eventually paid.
  • Not tracking contractor payments separately, missing a required 1099-NEC filing.
  • Assuming a 1099-K is the only record needed at tax time — it doesn't include any of your expenses.

Best practices

  • Reconcile books monthly using dedicated bookkeeping software connected to your business bank account and marketplace sales channels.
  • Automate a percentage-of-profit transfer into a tax savings account with every payout.
  • Revisit business structure with a tax professional at least every year or two, and definitely after a significant revenue jump.
  • Keep a running, categorized expense log rather than a shoebox of receipts to sort at year-end.

FAQs

Do I need an accountant, or can I do this myself? Many early-stage sellers manage their own bookkeeping with software, but a tax professional is worth engaging at least for your annual filing, and earlier if your structure, multi-state exposure, or revenue is getting complex enough that a mistake would be costly.

How much should I set aside for taxes? This depends heavily on your profit margin, business structure, and personal tax situation, so there's no single safe percentage to quote — get a specific estimate from a tax professional based on your numbers rather than using a rule of thumb from elsewhere.

What's the difference between a business expense and COGS? COGS is specifically the cost of the inventory units you sold (product cost, often including inbound freight/duties). Other business expenses (fees, ads, software, etc.) are operating expenses, tracked separately — both reduce taxable income but they're different categories on your return.