Drop Shipping Sales Tax Responsibilities
Dropshipping is a popular retail model that allows a seller to make a sale but have the product shipped from a supplier or vendor. This is a huge benefit to the seller because they don’t need to have their cash tied up in inventory as a traditional retailer that sells direct to the customer. The part that is more complex is the sales tax responsibility in the drop-shipping model. This has changed dramatically since the 2018 Wayfair vs South Dakota, where a seller may have economic nexus in up to 44 states. Each state a seller has nexus, they need to register to collect and remit sales tax.
Here is an overview of the drop-shipping model and sales tax requirements.
Drop-shipping will generate a request from your vendors to provide a resale certificate. This will protect the vendor from charging you sales tax as you are selling the product for resale. Unfortunately, there is not just one resale tax certificate to obtain which will satisfy every vendor.
Each state has a resale exemption, but what they will accept to document that exemption is different.
You will need to know which states each of your vendors want a certificate for.
Drop-shipping involves three parties:
- Consumer (buyer/customer)
- Seller (you/retailer)
- Vendor (shipper/manufacturer- ships the product to the consumer/customer)
There are two transactions involved:
- Between the consumer and the seller.
- Between the seller and the vendor.
The second transaction will determine the resale certificate that is required (between seller and vendor).
The vendor may be registered in many states (there are 45 that have sales tax plus the District of Columbia (D.C.).
You will need to determine which state’s rate is charged. To determine that, you will need to know where the sale is sourced. You must look to the state where the product is delivered to the consumer (your customer); that is called the “ship to” state.
Once a vendor is registered in a state to collect sales/use tax for that state, they must collect tax on every transaction delivered into that state. The exception for the vendor comes into play when they ACCEPT a PROPERLY complete exemption/resale certified in lieu of (instead of) collecting the tax.
Basically, after the vendor is registered in each state to collect and remit sales tax, they either have to collect and remit the sales tax on the sale of a taxable product or provide an exemption certificate on that sale.
Key point: the exemption certificate must be acceptable to the state where the tax is being charged.
Challenge: The seller is probably not registered in most of the states where they are asking the vendor to ship purchases. Example: if you were also a Shopify, you may have economic nexus in 25 states and may already be registered to collect and remit sales tax, but not the other 20 states (that have sales tax) where you may have customers.
The exemption certificate MUST be acceptable to the ship-to state and if the seller is NOT registered in the ship-to state, how can the seller provide the correct documentation?
This is important because if the sale for resale cannot be properly documented, then the state will NOT recognize it as a sale for retail. This means the vendor (the one shipping the product to your customer) will be required to charge sales tax. Keep in mind, the location of the customer never plays a role in whether a tax should be charged.
Solution: 36 states will accept documentation WITHOUT a seller having to be registered if the seller does NOT have nexus (if the seller did have nexus, they would already be registered in that state to collect and remit sales tax). Some states will accept multiple types of documentation and other states are limited.
Challenge: 10 States (CA, CT, D.C., FL, HI, LA, MA, MD, MS & TN) it is most likely that the SELLER will need to register to collect sales tax to issue a VALID resale certificate.
Strategy Option in These 10 States: In these 10 states, should a drop shipper register for sales tax? Yes, and here is why. Once you (the seller) register for a sales tax permit and resale certificate, you will have to collect sales tax and remit in these 10 states.
Yes, there are compliance costs, but usually, they add up to less than having to pay the vendor sales tax out of their own pockets. The average sales tax rate is 8%. That would mean you, the seller would sell to your customer and you would pay the 8% back to the vendor out of your profits. Why? Because you don’t have a resale certificate, and to get one in these 10 states you must be registered first.
What about California? If you are a legal entity (LLC or Corporation, for example), California now requires you to pay an annual franchise tax fee of $800 plus filing a state income tax return. These costs add up; but, again, are likely less than the sales tax you would pay out of your own pocket, especially considering California will likely represent 13+% or more of your overall total sales. California will charge sales tax on your selling price PLUS a 10% assumed markup if they don’t know your retail selling price.
Example: You have a resale certificate in one state, for example, NJ. You drop-ship a taxable item to a state where you do not have nexus (so you are not registered) but the drop-shipper does have nexus (Vermont). The vendor would charge you (the seller) for the sales tax. How do you get around NOT paying the sales tax out of your own pocket?
In Vermont, you need a resale certificate for your vendor. There is an alternative, but a caution.
- Vendors will request resale certificates in multiple states and that no one certificate will work in all states.
- This does not mean you have to get registered in every state, because most vendors are not registered in every state.
- Ask your vendor (a key point in your vendor selection process, not necessarily the most important) is where will they require exemption certificates (which should equal the states they are registered).
- If you want to start off with one state to apply for an exemption certificate and to get registered, and you are considering Wyoming vs California, California is recommended because it will work in both states (but Wyoming won’t work in California) and most vendors will require a California Certificate.