Resale Certificates Sales Tax 101 Shipping

Drop Shipping and Sales Tax, Demystified

by Mark Faggiano

Drop Shipping Sales Tax Explained

Sometimes your small business takes an order for a product you don’t actually have at your location. You might not even actually carry that item, nor have you ever carried that item. However, because you love your customers and want to cater to their needs, you ordered the item from a third party; maybe a wholesaler warehouse, or a manufacturer.
If you’ve ever done this in the past, or were thinking about pulling off this type of transaction, this is called a drop shipment. While it’s definitely not the most common way of conducting an eCommerce business, drop shipping can be part of a very lucrative business model.

Unfortunately, a drop shipment can make you decidedly unhappy at sales tax collection time.

To recap: your customer bought the item from you, and you bought the item from a wholesaler or manufacturer. You sold the item, but your source shipped it. To make matters tougher, all three parties in this transaction may be in different states, with different sales tax rules.

Drop shipping creates the following questions when it comes to sales tax:

  • Who pays the sales tax? Is it you, because you bought the item to then send to the customer? Or is it the buyer?
  • Who receives the sales tax and remits sales tax to the state taxing authority? Is it you, or the wholesaler who actually shipped the product?
  • What state taxing authority is the sales tax even remitted to? This is all dependent on who pays the tax and where they are located.

To clear this mess up, let’s investigate drop shipping and sales tax further.

Sales Tax Nexus and Drop Shipping

The reason drop shipping creates such headaches for sellers is the “sales tax nexus” issue. Depending on where you operate your business or where you’re selling the item and getting it shipped, nexus could come into play. Even MORE confusing: there are two ways nexus could affect sale tax when it comes to drop shipping.

Let’s say you already know you have nexus in the state. For example, you have an office in Pennsylvania and know that you have nexus when a customer buys something from you in that state. In this case you would collect sales tax from the customer no matter what method – traditional shipping or drop shipping – you use to get the item to the customer.

In a nutshell, if you use drop shipping in Pennsylvania and you have nexus there, you’d be the one to collect sales tax, not the wholesaler.

On the other hand, if you don’t have nexus in Pennsylvania but the drop shipper does, they could be responsible for collecting sales tax. However, this depends on the state, and the drop shipper would have to check if they qualify. Plus, you have to make sure that you and the wholesaler on the same page to avoid either double charging for sales tax or not charging for sales tax at all. (Which is something you definitely don’t want to do when it comes to the aggressive state of Pennsylvania.)

If neither of you have nexus in the state where your buyer is located (for example, you are in Florida, your wholesaler is in Arizona and your customer is in New York) then the customer is likely responsible for use tax on that item, since neither you nor the wholesaler have collected sales tax on that purchase.

Creation of Nexus

That’s not the end of the story, though. You might recall that the definition of “sales tax nexus” changes from state to state. Some states have come out and stated that they consider drop shipping one way to establish sales tax nexus.

Even worse, each state has their own rules on when and how drop shipping creates nexus. One state might declare that even a single drop shipment to a customer creates sales tax nexus for you or for the drop shipper (and thus you must collect sales tax from that customer and remit it to that state.) Another state might declare that drop shipping also creates nexus, but not until you or the wholesaler have shipped $50,000+ worth of goods. If this is the case, then you need to keep a close eye on your sales tax compliance should you near that $50,000 threshold.

Sales Tax Exemptions

So far, this sounds fairly simple, right? But, as we’ve often found with anything sales tax-related, there’s a wrinkle.

In this case, we’ll call the original party, who is drop shipping the product, the “Supplier.” The person who sold the product to the customer is the “Retailer.” And the customer is the “Buyer.”

For the most part, when a retailer buys a product from a Supplier, that purchase is tax exempt because the product was bought for resale. But, the states want to collect their tax, and in their eyes, someone has to pay up. So if the Retailer does not have sales tax nexus in the state where the product is purchased, the Supplier may be on the hook to pay sales tax.

That is, unless the Retailer can provide the Supplier and/or the state with a “sales tax exemption.” As with anything sales tax related, every state has their owl rules and procedures for obtaining drop ship exemptions.

A great article on SalesTaxSupport.com explains:

It is important to note that states vary in their rules regarding the exemption documentation that can be used in order to substantiate a sale for resale in drop shipment situations. Some states have developed alternate documentation rules. Depending on the jurisdiction, acceptable documentation can include home state registration or resale certificates, the MTC Multi-Jurisdictional Exemption Certificate, the Streamlined Sales Tax Exemption Certificate, the ship-to state resale certificate with the home state number or a no nexus statement or other alternative documentation that demonstrates that the transaction truly is a sale for resale. (Source: Drop Shipments: Third-Party Shippers and other Multi-Address Scenarios)

In other words, sometimes all members of a supply chain must cooperate to determine sales tax nexus. If you do not, then this could create hard feelings or worse… big penalties.

For an example of how convoluted drop shipping can get, you might want to check out this thread attempting to untangle sales tax liability regarding a 4-party drop shipment. After reading through this, it’s a wonder drop shipping remains as popular as it does.

How Much to Collect

Once you have figured out who collects sales tax, you still have to abide by state rules on how much sales tax to collect. Depending on if the state is origin-based or destination-based, you have to collect sales tax based on your location or that of the buyer. On the bright side, this is the one aspect of drop shipping that most eCommerce sellers are accustomed to dealing with.

Conclusion

Drop shipping is one of the more complicated aspects of sales tax law. Even the most seasoned sellers often find it difficult to keep track of state rulings and sales tax nexus definitions.

Check out this post for some common dropshipping scenarios and how to handle sales tax in each of them.

We highly recommend that you consult an accountant with experience with sales tax if you plan to embrace dropshipping in your eCommerce business model.

  • Stephanie

    Hi Mark! I live in California and my drop shipper is in California. So I just pay California taxes…Correct?

  • Hi Stephanie, As long as you don’t have sales tax nexus in another state through a physical presence, sales person, employee, affiliate, etc. then yes, you’d only need to collect sales tax from buyers in California.

    • Lou

      If I am selling online clothing in my nexus state of Vermont which exempts clothing from tax, I believe that I would not be required to collect any sales tax from any buyer from any State.

  • Rui

    Hello! I live in Michigan and my dropshippers are all overseas in China. Am I still responsible in any way for filing sales taxes? Thank you.

  • We can’t give specific tax advice, but it appears you don’t have to deal with U.S. sales tax in this situation – unless any part of your supply chain or customers are in the U.S.. That said, you may be responsible for taxes or duties in China. It’s always a good idea to check with a sales tax expert. Here’s a list: http://www.taxjar.com/sales-tax-accountant-directory/

  • Madeline

    Hi, I live in Utah. I drop ship to all states in the US. The sales tax people here in Utah tell me I have to pay them sales tax on everything I sell on the internet regardless. I know I must pay sales tax on drop ship items I sell in the state of Utah and any product I ship personally. Some of my suppliers have charged me sales tax for drop ship. Those I know I don’t have to worry about. So, is it my understanding that states that have nexus I must pay sales tax to that state. Thank you for your help.

  • Hi Lou, From the information provided, that sounds right. You only need to collect sales tax on taxable items in states where you have sales tax nexus. Always consult with a reputable CPA or sales tax specialist if you have questions specific to your case.

  • Robin

    Do I have to collect sales tax on items that I paid sales tax on at the time I purchased them? I sell both on eBay and on FBA-Amazon. I live in Texas.

  • KCars

    Hi Mark, my office is in NY, my wholesaler is in CA, and my customers place orders via email for the wholesaler to drop ship it to them in FLA. Do I have to charge my customers from FLA NY sales tax even though the tangible item never physical touched NY? THANK YOU!

  • Hi Robin, Yes, you do. The state cares about collecting tax on the sale rather than on the individual item.

  • Ky

    Hi Mark,

    I am in NJ, and my retailer is in NJ too.
    Both have nexus only to NJ.
    Do you think it is possible that the retailer collect a tax in NJ and transfer the money to me to remit the tax?

  • hfm2015

    my company is based in FL, my drop shipper in CA. I don’t have a sales tax certificate in CA, so if sell to a customer in CA and ship from my supplier in CA, can I just pay the taxes to my supplier/drop shipper and don’t collect sales tax from my customer?

  • I highly recommend consulting an accountant on specific questions. We’re not CPAs, so can only deal in generalities and can’t give you advice specific to your situation. Here’s a list of CPAs who we know specialize in sales tax: http://www.taxjar.com/sales-tax-accountant-directory/

  • As you can tell from this post, drop shipping is very complicated and every drop ship relationship is different. We highly recommend consulting an accountant on specific questions. We’re not CPAs, so can only deal in generalities and can’t give you advice specific to your situation.

  • don

    Hi, I live in Tennessee and have a llc registered in Delaware. it’s a drop ship resell business. In which state do I apply for a resellers permit and do I charge sales tax to items sold to Tennessee residents or pay the gross receits tax Delaware charges since they do not have a sales tax. any advice is helpful.. Thanks

  • Hi Don, While we can’t give out advice specific to this situation, here’s what we have on drop shipping: http://taxjar.wpengine.com/drop-shipping-sales-tax/

    And here’s our list of vetted sales tax experts: http://www.taxjar.com/sales-tax-accountant-directory/

  • feeling dim in CA

    I have an ecommerce site in CA, with a collection of dropshippers in MI, NV, NY, OR, CO. They all tell me I’m responsible for collecting sales tax since I’ve made the direct sale to the buyer. Some are even telling me they can’t give me tax advice?! Are they correct about the collection of sales tax happening via my site from the Buyer? If not, and I do push back to get them to pay a use tax in their state, does TaxJar manage this somehow? Would like to know before we install to our site.

  • Hi there,

    I highly recommend that you contact a sales tax expert for this question. We, unfortunately, also can’t give you direct sales tax advice. We do have a list of vetted sales tax experts, which can be found here:

    http://www.taxjar.com/sales-tax-accountant-directory/

    Good luck with your question!

  • ofir

    I live in israel and i’m doing drop shipping from Amazon FBA to eBay, and i’m pay tax for each purchase on amazon. Do I have to charge sales tax to my customers?

  • Michael

    Hi, I live in Australia and use online arbitrage to list items on ebay.com > sell within the US only > dropship using Amazon. I have no nexus or business ties within the US. Am I required to charge my eBay buyers sales tax and am I obliged to pay sales tax to Amazon?

  • entrepreneur

    Hello,
    Does it any form which I can sign with Supplier to solve all these tax problems for my situation?
    I live outside the US and there is no sales taxes in my country. Also I work via drop ship with several suppliers in different States of the US. My buyers are also from different states of the US.

    Will ‘The Multijurisdiction Resale Certificate’ with each of my suppliers be O.K in my situation in case I’m not resident of the US?

    • Hi there,

      We recommend you contact a CPA familiar with international sellers. We recommend Sylvia Dion and you can find out more about her at SylviaDionCPA.com. Good luck with your business!

  • Hi Michael,

    We always recommend you contact a sales tax expert for specific questions about your business. Here’s a list:

    http://www.taxjar.com/sales-tax-accountant-directory/

    it depends on your drop shipping relationships. Are they charging sales tax? If not, you may be on the hook for it. Here’s more about dropshipping. Look for your scenario here: http://taxjar.wpengine.com/drop-shipping-scenarios-sales-tax/

  • Pingback: Sales Tax Nexus Defined - Learn all about Nexus()

  • Justin Ritter

    Thank you for writing this article. Its the best analysis on the subject I’ve found.

  • HitTheDeck000

    I live and operate an eCommerce store from my home in Illinois. My dropshippers are from Utah and Puerto Rico/Texas. I know I have a nexus with Illinois and have to charge tax to customers from there but what about Utah or Puerto Rico/Texas? Do i charge tax to customers from there as well since my drop shippers are from there? Also, do i need to register with those states and file taxes to them as well? Thanks!

  • HitTheDeck000

    I live and operate an eCommerce store from my home in Illinois. My dropshippers are from Utah and Puerto Rico/Texas. I know I have a nexus with Illinois and have to charge tax to customers from there but what about Utah or Puerto Rico/Texas? Do i charge tax to customers from there as well since my drop shippers are from there? Also, do i need to register with those states and file taxes to them as well? Thanks!

  • Pingback: WooCommerce Sellers Sales Tax Guide()

  • Pingback: Resellers: How to Recover Sales Taxes Charged by Vendors()

  • Pingback: The 5 Basics of Sales Tax Retailers Need to Know - Stitch Labs()

  • Pingback: The Benefits of Drop Shipping | ChatVersion()

Start your 30 day free trial of TaxJar. No credit card required.
Processing...
Thank you! Your subscription has been confirmed. You'll hear from us soon.
Subscribe to the TaxJar Sales Tax Blog
ErrorHere