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Dropshipping is a popular business model which allows entrepreneurs to expand their e-commerce businesses without having to purchase and store inventory. Drop-shipments can be very complicated when it comes to sales taxes.
This blog post will help you to understand the complexities and give you guidance on where to register for sales tax permits.
What is Dropshipping? Why Is it so Complex?
Dropshipping can be complicated because of the involvement of three parties.
First is the retailer who accepts orders online from customers and sends them to the manufacturer/wholesaler. Next is the manufacturer/wholesaler who receives orders from the retailer and ships the product directly to the customer and bills the retailer for their products. The customer who orders the product online is last. He or she is probably unaware of all the details.
This scenario applies to dropshippers as retailers.
(1) Where you, the retailerare supposed collect sales tax
(2) where the manufacturer/wholesaler has sales tax nexus and needs appropriate resale documentation from you.
Dropshippers are supposed to collect sales tax?
Dropshippers must collect sales tax wherever they have sales tax. Sales tax nexus is a complex topic, but in general, you need a sales tax permit anywhere you have a physical presence or meet certain economic nexus thresholds. You can find our series of blog posts on nexus state-by-state on our website.
If you own any of these, you will likely need a sales permit.
- A place or office in the state.
- Stock or warehouse that is kept in the state
- State employees and independent contractors
- You can own real and personal property in the state
- You can deliver merchandise to the state in your vehicle
- Reach the state’s economic threshold (typically, $100,000 in sales annually or 200 transactions).
This list does not contain all the information and should be considered a starting point. To determine if your state has a sales tax collection obligation, we recommend that you research the individual state statutes. Or, if you need help determining where you have sales tax nexus, you might benefit from our Sales Tax Starter Kit service.
Once you’ve established that you have sales-tax nexus in a particular state, you can apply for a sales permit.
Are You Just Starting?
You might not need sales tax permits or sales tax nexus if you’re just starting out and don’t have any physical presence in the U.S. To account for resale certificate, however, you may need to obtain sales tax permits from your supplier.
What if your dropshipper requests Resale Certificate Documentation
Dropshippers’ number one problem is not where they have sales nexus. It is where their suppliers have the sales tax.
Your suppliers will bill you as the retailer for the products they ship to end-consumers. They must charge sales tax unless you can prove to state that the sales were exempt from tax because they were being resold to you. You must provide the supplier with appropriate resale certificates documentation.
Suppliers often ask retailers for resale certificates documentation. This is valid in all states that have sales tax nexus. Don’t be alarmed if you get a letter asking for resale certificates from dozens of states. There is a way around it.
If your supplier asks for documentation to support a resale certificate, it does not necessarily mean you have to go get sales tax permits in every state. Many states permit you to use an outside-of-state sales license when completing the resale certificate documentation.
You can, for example, use your California sales tax permit to provide the correct resale certification documentation to your supplier without needing to register in every state they are asking for it.
Keep in mind that you will need to collect and remit sales taxes in the state you get a sales permit to give proper resale certificates documentation to your vendor.
Dropshipment is when a seller accepts an item from a customer and then places it with a third party supplier, usually a manufacturer or wholesale distributor. The manufacturer then ships the goods directly to the customer. The manufacturer/supplier bills the retailer for the wholesale price and the retailer then bills the customer the retail price. The state rules must be observed and the tax applicable is the state in which the goods were delivered to the customer.
The final consumer is subject to sales tax in the United States. A retailer should be allowed to buy items that are exempted from sales tax under the exemption for resale. The retail transaction between the seller or customer is considered a transaction. Taxes are assessed based on the nature of the goods bought and the customer’s type. Retail transactions are not between the manufacturer or the customer. Therefore, the manufacturer should not be held responsible for collecting tax based upon the retail price. The transaction between the retailer and manufacturer is deemed a resale transaction. It should be exempted from the resale exemption that applies in every US State.
For dropshipments when the retailer does not have nexus in and is therefore not registered to collect sales tax in the delivery state, most (but not all states) permit the manufacturer who does have nexus in the delivery state to accept alternate documentation to substantiate a sale for resale to the retailer. Otherwise, the manufacturer/supplier would be required to collect tax on its sale to the retailer even though it is really a sale for resale. Be aware that exempt sales can only be exempted if the documentation is correct.
Now the question is, then, how do you document it? The primary rule is a resale certificate for the ship to state issued by the retailer. But, the question is, can a retailer legally issue a ship-to-state resale certificate if they aren’t registered with the ship state? The answer to most questions is yes in most states. It all depends on what the state will accept. This can be the home state (retailer’s state) resale certification. In others, it will be the ship-to-state resale certificates with information or notations about the state registration number. Some states will accept a multistate resale certificate or exemption form, such as the Multistate Tax Commission’s (MTC), exemption certificate with the state registration number, or, in the Streamlined State, the Streamlined Sales Tax Exemption Certificate with the state registration number. Only a few states will accept an affirmation of no nexus.
There are 10 states that require a registered number on either their MTC or their own forms to obtain a valid resale certification. If the customer is exempt or is reselling the goods, some states will allow a pass-through exemption. This would mean that the retailer must issue both the home state certificate and the exemption certificate for the ship to customer.
Drop Shipments can be very difficult and frustrating for both suppliers and retailers. Suppliers will not accept any other shipping certificate than that issued by the state. This will lead to frustrated customers (retailers), who won’t have the responsibility for paying the tax. It also results in increased costs to the end customer, as they still owe the use tax if the retailer doesn’t charge them tax. Retailers are not allowed to separately list the tax that they may be charged by the supplier unless they have been legally authorized to collect the state’s tax.