Summary: Drop-shippers should apply for sales tax permits wherever their business has sales tax nexus. Also, you should consider any resale certificates documentation that your suppliers might request.
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 is intended to help you understand the complexities and give you guidance on where you should register for sales taxes 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. Although sales tax nexus can be complex, it is generally true that you will need a permit to collect sales tax wherever you have a physical presence, or meet certain economic thresholds. Our blog series on nexus state by state can be found 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. You might also benefit from our sales tax starter kit service if you need assistance determining where your sales tax responsibility is.
Once you have determined that you have sales-tax nexus in a particular state, you need to 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 are located, but where their suppliers are located.
Your suppliers will bill you (the retailer), for the products that they ship to end-consumers. They must charge you sales taxes on every order , unless you can prove to the state the sales should be exempted from tax because it was being sold by you to end-consumers. You must provide the supplier with appropriate resale certification 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. Why? 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.
Click to see the resale certificates for each state.
However, there is a catch. Some states won’t accept resale certificates from outside their state. This blog post explains more.
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.
A Few Examples (Because This Stuff Is Confusing)
Example 1 : You have a California sales tax permit and you are dropshipping to Georgia. Your supplier doesn’t have sales tax in Georgia. There is no sales tax nexus for Georgia. A permit is not required in Georgia. You don’t need to collect sales tax in Georgia.
Exemple 2: You have a California sales tax permit and you are dropshipping to Georgia. Your supplier doesn’t have sales tax nexus to Georgia. Georgia does not have a sales tax nexus. If you don’t provide the proper documentation for resale, your supplier will charge Georgia sales tax. Georgia doesn’t require you to have an in-state permit in order to provide proper documentation for resale certificates.
Example 3 : A California sales tax permit is in place and you are dropshipping to a customer Florida. Your supplier doesn’t have sales tax nexus to Florida. There is no sales tax nexus for Florida. If you don’t provide the proper documentation for resale, your supplier will charge sales tax. Florida requires an in-state permit to provide proper documentation. If you wish to purchase inventory from your supplier tax-free, you will need a permit in Florida.
TaxValet’s Done for You Sales Tax Service can help you with specific questions or to determine where you will need permits.
Dropshipping is a great way to expedite order fulfillment, especially during busy holidays. Dropshipping can complicate compliance with sales tax.
Dropshipping is when a retailer buys product from a supplier (also known as a drop shipper) after receiving an ordered. This is in contrast to buying inventory in bulk ahead. The supplier then ships the order directly from the manufacturer to the customer. This model is easy to scale and reduces overhead.
Dropshipping can complicate sales tax compliance as it involves three parties, two sales transactions and often multiple states. Each state has its own tax rules. It is not always clear who is responsible for collecting and remitting the sales tax: the retailer, the supplier or the consumer.
It is important to establish where the supplier and retailer have nexus in order to figure out who is responsible for paying tax on dropshipping. Nexus refers to the link between a business entity and a state, which establishes a tax collection responsibility. Although nexus was traditionally defined as physical presence, some states have expanded the definition to include economic activity, referrals and relationships with affiliates.
One tax policy doesn’t necessarily fit all. Dropshipping is one of three scenarios that can be used, each with a different tax impact.
Scenario 1 : The retailer has nexus.
In general, a retailer with nexus in the state of a consumer is required to collect sales taxes from that customer and remit it back to the tax authorities. Even if the supplier ships product to the customer, this applies.
The sale of the supplier to the retailer in this instance is exempted as a sale for future sale. The retailer would issue the supplier a resale or exemption certificate to confirm the exempt transaction.
Scenario 2 : Neither the supplier nor the retailer have nexus.
If the retailer or the supplier have no nexus with the consumer, neither can they be required to collect or remit sales taxes. Consumers are responsible for reporting and paying tax.
Consumers are responsible for paying the equivalent amount of consumer use tax to tax authorities, instead of the sales tax. Some states allow consumers to report their consumer use tax annually on their state income tax returns. In some states, a separate consumer tax return is required.
States have difficulty enforcing use tax compliance and compliance is very low. Some states now require vendors that do not collect use tax to notify consumers that may be due. They may have to report the purchase activity of consumers to both the vendor (so that they know how much they owe) and to the state (so that they know how much the consumers owe).
Scenario 3 – The drop shipper (supplier) has nexus but the retailer does not.
If the supplier doesn’t have nexus within the state where the sale takes place, then the supplier could be required to collect tax from the retailer unless the retailer provides a valid exemption certificate or resale certificate. This is the most difficult scenario.
Around 30 states allow suppliers the ability to accept exemption certificates from retailers out of state. Since no tax is collected on either the retailer’s sale or the supplier’s sale, exemption certificates from out-of-state retailers are generally acceptable.
Around 16 states prohibit suppliers from accepting certificates of exemption from other states. These states are the most difficult for sales tax compliance.
These states may require that the supplier collects tax on wholesale prices paid by the vendor. The Maryland Comptroller states, for example, that the supplier must either require the vendor to obtain a Maryland tax license and provide a valid certificate of resale or charge the vendor tax based upon the amount of the sale.
Some states also require suppliers to collect tax on retail prices charged to customers. Many retailers won’t share their retail prices with suppliers so there is usually a Plan B.
For example, in California, a supplier who doesn’t know its final retail price must add 10% to the wholesale price and then charge the retailer tax (wholesale plus 10%).
However, in Connecticut if the supplier does not know the retail selling prices, it should charge the retailer the wholesale price. Then, “the customer” is responsible for paying the rest of the tax to the State.