Resale Certificates Sales Tax 101

Sales Tax 101: I’m in a Drop Shipping Relationship. Now What?

by Ned Lenhart

Dropshipping and sales tax demystified

Third-party drop shipments are becoming one of the most common ways that eCommerce companies use to fulfill their customer’s orders.

What is Drop Shipping?

As a refresher, this “drop-shipment” relationship occurs when your vendor ships the product directly to your customer and bills your company for the purchase you made from them. In a traditional drop-shipment transaction, two separate sales occur simultaneously at the point the goods are delivered to your customer.

The first sale to occur is between your vendor and your company. This first sale is, most likely, a “sale for resale” from your vendor’s perspective. Your vendor is billing you for the purchase price of the items your company has purchased and had delivered to your customer. There is a transfer of title from your vendor and your company at the moment the goods are delivered to your customer. Upon delivery, the second sale occurs. That sale is between your company and your customer. This sale is documented by the sales proceeds you receive from your customer for the goods they purchase. Assuming that your customer is the end-user of the products sold, this second sale is a retail sale and is taxable as dictated by the laws of the state where your customer is located.

This all sounds very convenient and as an easy way to manage inventory and meet your customer needs in a timely fashion. It also presents a myriad of sales tax challenges that the states are willing to capitalize on whenever possible to make sure that taxes are paid by someone on these transactions. With two separate sales occurring in a drop shipment transaction, there are two separate sales tax decisions that need to be made. Each of these sales tax decisions requires that two questions be answered: (1) do either of the sellers (your vendor and your company) have nexus in the destination state? and (2) is the sale to either customer a “sale for resale”?

Why Sales Tax Nexus Matters

Of the two questions, the issue of nexus is vital to determining the responsibility each party has for sales tax in the destination state. As noted above, the first transaction involves the sale of the property from your vendor to your company. If your vendor has nexus in the state where the property is delivered to your customer, then some type of resale certificate must be provided by your company to your vendor to prevent your vendor from charging your company sales tax on the wholesale cost of the goods sold to you.

If your company has nexus in the state where the drop shipment occurs, then your company will need to obtain an exemption certificate from your customer or your company will need to charge your customer sales tax on the retail cost of the property and any delivery charges that may be taxable.

Find Your Drop Ship Scenario Here

There are several scenarios to evaluate. For simplicity, these scenarios assume that each party to the drop shipment is located in a different state and that the goods are shipped from outside of the destination (i.e. end-customer’s) state.

Scenario 1: Neither your vendor nor your company has nexus in the destination state. In this case, your vendor does not have a legal obligation to obtain exemption certificates that are valid in the ship to state and your company does not have the legal obligation to charge sales tax to your customer (assuming they are the end user). In this situation, the customer will be obligated to pay use tax to the destination state.

Scenario 2: Your vendor has nexus in the destination state but your company does not. In this scenario your vendor should be asking your company for a resale certificate that is valid in the destination state. What is valid in the destination state will vary. Many states will accept your company’s “home” state certificate or will accept your “home state” registration number on the certificate issued by the destination state. Some states, however, are very rigid and will only accept a resale certificate from the destination state with a registration number issued by the registration state. If the ultimate customer is not taxable, some states will allow a “flow through” of your customer’s resale certificate. This option is normally available only when your company does not have nexus. Your failure to provide your vendor with the appropriate resale certificate could legally obligate them to charge your company sales tax on the wholesale price of the property based on the tax rate at the destination location.

Scenario 3: Your vendor does not have nexus in the destination state but your company does have nexus in the destination state. In this scenario, your obligation is to collect the appropriate sales tax from your customer based on the tax rate at the destination location.

Scenario 4: Both your company and your vendor have nexus in the destination state. In this case your vendor will be expecting to receive a resale certificate from your company that is valid in the destination state and your company will be obligated to collect tax from your customer if the sale is taxable. If the sale is not taxable, your obligation is to obtain a valid resale certificate from your customer.

In states like California that have a very rigid structure around resale certificates, vendors with nexus in that state will be expecting your company to provide them with a certificate that is valid in California. Your company’s failure to provide that certificate will cause your vendor to charge your company sales tax on the transaction. Your failure to provide a resale certificate turns this “resale” transaction into a taxable “retail” transaction. This can pose a real dilemma for companies that don’t have nexus in the ship to state (such as California) but have drop-shipments made to these customers. If your customer is a wholesaler and your company does not have nexus in California, then your customer can provide your vendor with a resale certificate directly.

To avoid being charged tax in situations like this the company has limited choices. First, the company can register with the ship-to state so that it can provide the requisite resale certificate. By virtue of registering for tax, the company is now accepting responsibility for collecting tax on these ‘drop shipments’ even though it may not have nexus in the state. Another option is to break the drop-shipment structure. In some situations, the tax cost is substantially greater than the additional shipping costs that would be incurred if the property were shipped to your company in the “home state” and then your company re-shipped the product to the customer in the destination state. The final option is to pay the tax charged by the vendor and just consider it an additional 8 percent to your cost-of-sales.

As a retailer using drop-shipments to fulfill orders your company may be facing some additional and unexpected sales tax obligations based on the nexus footprint of your vendors. Thankfully, most of the states will accept the “home state” certificate or the “home state” number on destination state’s exemption certificate. In those few state which don’t accept ‘home state’ certificates, your company may be confronted with some unexpected tax costs or some unexpected administrative costs related to registering and collecting tax from customers in state where your company does not have nexus.

As states become more aggressive on audits, your vendors will likely be the first ones to feel the sting when they determine under audit that they don’t have a valid resale certificate from your company in a state where they have nexus and have ‘drop shipped’ products to your company’s customers. Do you have questions about dropshipping? Start the conversation in the comments.

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  • Jason Kim

    I am located in Canada, and recently opened an ebay store to start dropshipping business. I am selling many products from other online marketplaces, such as Amazon sellers, ebay sellers, sellers at sears.com, and so on, to customers in States. Obviously most of them are online sellers/retailers, not vendors. And I am paying sales taxes to the online sellers whenever they are applicable. In my case, should I NOT charge any sales taxes to my customers?

    • Hi Jason,

      If you’re selling to other retailers as a distributor, then you should ask each of them for their sales tax exemption certificate. If they can provide that, then you don’t need to charge them sales tax. I hope that answered your question!

  • Joseph

    Can my customer provide a resale certificate to my vendor for the state of Florida? I have no nexus in Florida.

    • They can, but if you’re already not charging sales tax in Florida I don’t see why the customer would bother. That said, they may have their reasons as well. Sorry I can’t be of more help in this matter! I do recommend contacting a vetted sales tax pro if you need specific help: http://www.taxjar.com/sales-tax-accountant-directory/

    • They can, but if you’re already not charging sales tax in Florida I don’t see why the customer would bother. That said, they may have their reasons as well. Sorry I can’t be of more help in this matter! I do recommend contacting a vetted sales tax pro if you need specific help: http://www.taxjar.com/sales-tax-accountant-directory/

  • Joseph

    Can my customer provide a resale certificate to my vendor for the state of Florida? I have no nexus in Florida.

  • James Hafeez

    Hi, I am looking to start a business where I dropship products from suppliers to US customers. Some of my suppliers will be in the US, others in Europe. I am based in Berlin, Germany and have no physical presence in the US. Do I have to pay sales tax?

    • Inventory creates sales tax nexus in many U.S. states, but drop shipping can be very tricky. I recommend you contact Sylvia Dion, a great international sales tax expert. Her contact info can be found at http://www.sylviadioncpa.com. Thanks!

  • Haley Hance

    Hello,
    I am in the process of starting an online clothing store, and my product supplier will be based in China. I have no physical warehouse or storefront of my own, but I will use my residence as a home office, which is located in Texas, US. I am hoping to drop ship products worldwide, but I don’t know exactly what my role is in the sales tax area of the transaction. I have already applied and received a sales tax permit for the state of Texas. So basically my question is, am I only responsible for collecting sales tax on orders drop shipped to Texas, because I reside in Texas? And it is the buyers responsibility in other states and countries outside of Texas US for paying due sales tax? Thanks!

  • Kate

    In the above paragraph, second from Scenario 4, it states “The final option is to pay the tax charged by the vendor and just consider it an additional 8 percent to your cost-of-sales.” In this situation, where the vendor charging the sales tax is located in State X and the final customer is located in State X as well but our company, as the retailer is located in State Y with no nexus to state X, if we would pay this tax and then invoice are customer without sales tax, would our customer have an obligation to pay use tax on this transaction as well?

    • (Hi Kate, I asked Ned Lenhart the author of this post to comment. Here’s what he said. – Jenn from TaxJar)

      Kate: Use tax will still be due from your customer (assuming that they are a taxable user and the product is taxable). If they do pay use tax, they will most likely pay it on the full sales price of the product. However, your company has already been charged tax by the seller on the wholesale cost of the product, so there is some double taxation. This double taxation is not really your concern, though. You need to select the best option for your company which minimizes compliance costs and additional costs.

      Ned A. Lenhart, MBA CPA
      http://www.salestaxstrategies.com

  • Hong Nhung Tran

    I live in Missouri, My customer live in another states. I bought item from amazon and paid taxes for them already, then i sold it to the buyer on ebay. I also collected the ebayer sale taxes to pay for amazon’s sale taxes. That’s just the dropship transaction and i’ve already paid taxes for amazon. Do i need to submit the sale taxes i collected from buyer to the state?

    • Hi there,

      It sounds like, in this situation, if you sold to a buyer in Missouri you should have collected sales tax. It’s helpful to think of sales tax as a tax on the transaction, not on the object. So just because you paid sales tax when you bought it doesn’t mean you don’t need to charge sales tax when you resale it. Also, to prevent having to pay sales tax on item’s you plan to sell again in the future, you can get a reseller’s permit from your state and present it when you’re buying inventory. I hope this helps answer your questions.

      • Hong Nhung Tran

        So, I live in missouri , and i have reseller’s permit from my state. if i buy on amazon and already paid tax to amazon and then using ebay to sell it to other states, , can i collect sale taxes from customers from the other states or just only customer in Missouri? If yes, what will happen if i over collected customer in other states? and do i need to submit sale tax from customer i collected to my state? How about paying tax based on my online income? To pay tax, is that mean i have to submit not only saletaxes i collected but also the tax base on my total profit?

        • Kevin

          You only charge tax to customers who are within your state. To charge tax to customers from other states you must have enough of a presence in the each of the other states that would invoke Nexus in those states.

          Income tax is a separate thing, I’m not sure TaxJar offers advice on income tax… As an educated guess, you would need to be a registered ’employee’ of this online business you have, declare the salary you are paying yourself from the profit it makes, and that will determine the income tax you pay. But if you are using the profit from sales directly, you might have to pay a company or corporate income tax from the profit, on top of the taxes you collect and remit from sales.

          Bear in mind I am no tax expert and what I’ve said here could be poppycock. You are always better off speaking to a professional.

        • Kevin

          You only charge tax to customers who are within your state. To charge tax to customers from other states you must have enough of a presence in the each of the other states that would invoke Nexus in those states.

          Income tax is a separate thing, I’m not sure TaxJar offers advice on income tax… As an educated guess, you would need to be a registered ’employee’ of this online business you have, declare the salary you are paying yourself from the profit it makes, and that will determine the income tax you pay. But if you are using the profit from sales directly, you might have to pay a company or corporate income tax from the profit, on top of the taxes you collect and remit from sales.

          Bear in mind I am no tax expert and what I’ve said here could be poppycock. You are always better off speaking to a professional.

          • Great answer. Thanks, Kevin!

          • Great answer. Thanks, Kevin!

  • mitchell

    Who is responsible for paying the sales tax? Lets assume everyone has Nexus. My company sends equipment to company A and company B will be paying for the equipment. (All 3 companies are in different states. NC, TN & VA) Company B is tax exempt, but the equipment is being used by company A.

    • Hi Mitchell,

      We recommend you contact an accountant for specific questions. Ned, the author of this post, is a good one to start. His website is salestaxstrategies.com. Good luck!

  • Cal Haugland

    California drop ship tax calculation is an issue I rarely see addressed correctly, and it is rare that the California businesses I work with understand their obligation regarding in-state drop ships on behalf of out-of-state sellers. In California, the CA drop ship vendor must charge the non-CA seller sales tax based on that seller’s retail price to the CA customer, or if that is unknown, an amount equal to the cost of the merchandise plus 10% (http://www.boe.ca.gov/formspubs/pub121/ — see the Amount of Tax Due tab). It was explained to me that If the CA drop ship vendor calculates sales tax based on the non-CA seller’s price to the CA customer, the seller can pass that cost along to the CA customer describing it as tax paid on behalf of the customer, which means the CA customer will not have to pay the sales tax a second time. Therefore, CA sales tax doesn’t have to become a COGS for the seller.

    In no case should the drop ship vendor ever charge sales tax to the non-CA seller based on the cost of the merchandise to the non-CA seller.

    Does Taxjar have a different understanding of this California BOE Publication?

    • Hi Cal, Ned Lenhart the author of this post isn’t a TaxJar employee, but he’s had a multi-decade career as a sales tax CPA. I suggest giving him a call or email if you have questions!

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