IRS Targets Amazon FBA Sellers with New ECI Tax Rule: What You Need to Know

The Core of The New IRS GuidanceAt the heart of the August 2025 policy shift is the concept of “Effectively Connected Income” (ECI). The IRS now explicitly states that foreign sellers who store goods in Amazon’s FBA warehouses, third-party overseas warehouses, or their own warehouses within the U.S. are likely to be considered “engaged in a U.S. trade or business” (USTB).

This designation means all income related to these business activities is deemed ECI and must be reported to the IRS using Form 1120-F, with federal income tax paid on the net profit.

The key change is the IRS's stance that physical inventory presence alone—like using FBA—constitutes a substantial and continuous business operation in the U.S., moving past previous thresholds that might have exempted smaller sellers16.Enforcement Powers and Penalties: A Stark WarningThe IRS is armed with significant enforcement capabilities. Failure to comply carries severe financial risks:Retroactive Audits: The IRS reserves the right to trace back 3 to 6 years of unpaid taxes for non-compliant sellers16.Substantial Penalties: Late payment penalties can be staggering, ranging from 50% to 200% of the original unpaid tax amount1.Default Assessment: If a seller fails to file Form 1120-F, the IRS can levy a tax directly on the gross sales revenue at a rate of 30%, which could be devastating for businesses operating on thin margins136.Why FBA Triggers ECI StatusThe IRS’s logic is clear and direct: storing inventory on U.S. soil to facilitate rapid sales to American consumers is a definitive operational presence. This applies uniformly, whether the stock is in Amazon FBA, a third-party overseas仓, or a seller’s own private U.S. warehouse.

Beyond inventory, other factors that can strengthen an ECI determination include owning a U.S.-registered trademark or patent, maintaining a local office, or employing personnel in the United States1.Real-World Impact: Seller Cases EmergeEarly effects of this clampdown are already visible. A Shenzhen-based lighting seller, caught off-guard by the new interpretations, was reportedly hit with a $237,000 bill for back taxes and penalties covering 2023 to 2025. This massive payment wiped out their 18% profit margin, effectively pushing it into negative territory and erasing two years of hard work.

Another seller from Dongzhou faced a “double whammy”—receiving tax deficiency notices from both the Chinese tax authorities and the IRS, presenting a complex challenge of potential double taxation and highlighting the new era of global tax transparency3.The Larger Regulatory ContextThis shift is part of a broader, global trend towards tightening tax compliance for digital commerce and is not occurring in a vacuum.U.S. Data Reporting: The 1099-K form reporting threshold for payment processors and platforms is a key tool for the IRS. The threshold dropped to $2,500 for the 2025 tax year and is set to fall further to a mere $600 in 2026, making virtually all sellers visible to tax authorities4.Global Momentum: Similar regulatory pushes are happening worldwide. Germany is aggressively auditing Amazon sellers, particularly focusing on missing ZM reports for intra-EU movements6. Vietnam and Mexico are also enforcing stricter registration and tax collection rules for foreign e-commerce businesses3.China’s Reporting Rules: Adding another layer of complexity, new Chinese regulations (State Council Order No. 15) require internet platforms to report seller identity and income information to tax authorities, ensuring overseas income of Chinese entities is no longer invisible domestically710.Strategic Paths Forward for SellersIn response to these changes, tax and legal professionals are advising sellers to take proactive steps1710:Immediate Assessment: sellers should immediately evaluate their ECI exposure based on inventory locations, U.S. assets, and trademark registrations.Form 1120-F Filing: Consider filing Form 1120-F for the current tax year, even if done as a "protective filing," to avoid harsh retroactive penalties. Engaging a U.S.-based CPA firm experienced in international tax is highly recommended.Long-Term Structural Planning:For many, establishing a U.S. corporation (e.g., a C-Corp) may become the most sustainable path. This local entity can then formally hire local staff, lease warehouse space, and file U.S. corporate tax returns (Form 1120), often qualifying for preferential tax rates under the new OBBB Act.Another sophisticated strategy involves a "Hong Kong company holding a U.S. subsidiary" structure to leverage benefits under the U.S.-China tax treaty.Implementing strict "identity, data, and capital isolation" between domestic and overseas operations is also becoming a critical compliance measure.A New Era of E-Commerce ComplianceThe IRS's 2025 guidance marks a pivotal moment, signaling the end of an era where cross-border e-commerce could operate in a tax grey area. “The era of full compliance for cross-border e-commerce has comprehensively arrived,” as noted in one analysis.

The message is clear: the perceived protective barrier between international online sellers and U.S. tax obligations has been dismantled. For businesses that thrive on Amazon.com, prioritizing tax compliance is no longer optional—it's a fundamental requirement for operational continuity and long-term viability in the world's largest e-commerce market.