Drop shipping can be a big boon for online sellers, especially small businesses that don’t have the funds or space to stock up on and store inventory. With drop shipping, sellers can take orders from customers for an item and then turn around and order that item from a supplier, which then ships it to the customer. The seller doesn’t have to handle the physical item at all, the customer gets his or her order, and everyone’s happy.
In many ways, this is a win-win, but using drop shipping can create complexity when it comes to sales tax.
Know your nexus
As with any sales tax situation, the first step is knowing where you have nexus, or a relationship with a certain jurisdiction that requires you to collect sales taxes. In general, if you have nexus in a state, you will be responsible for collecting the right rate of sales tax for that state on any sales to customers within that state. That applies whether you are using drop shipping or delivering in some other way.
What if you don’t have nexus, but your supplier does?
Drop shipping can be tricky precisely because it’s not only the seller’s nexus that comes into play, but, potentially, the supplier’s or shipper’s nexus as well. As the seller, you are generally only obligated to collect sales taxes on a sale if you have nexus in the customer’s state. However, several states hold a supplier with nexus in that state responsible to collect sales taxes on the sale when the seller lacks nexus, including California, Connecticut, Florida, Hawaii and others. In turn, the supplier’s obligation could require you as the seller to either pay sales tax to the supplier or to come up with an exemption certificate so that you don’t have to pay tax.
In most states, sales taxes are only levied on retail sales, not wholesale transactions. In this case, even if your supplier has nexus, the supplier will not have to collect sales tax on the transaction with you as long as the supplier can present a valid resale exemption certificate from you, the seller.
However, even if the sale between you and the supplier is exempt, if you don’t provide the supplier with a valid resale exemption certificate, that transaction can be considered a retail rather than a wholesale sale and could legally obligate the supplier to charge you sales tax on the transaction.
Resale exemption certificate procedures are individual to each state. Many states will accept an out-of-state resale certificate, multijurisdictional form or alternate documentation in a drop-shipping situation.
However, in the states that don’t accept these, the seller may have to deal with some unexpected requirements. For example, in California and other states that have stricter requirements for resale certificates, a seller may have to register with the state in order to provide a valid exemption certificate. By registering in order to get that certificate, the seller would now be obligated to collect sales taxes from customers in that state even though the seller previously did not have nexus.
Creating nexus with drop shipping
In some states, the use of a drop shipper in the same state as the customer by an out-of-state retailer can create nexus for the seller. States where this may be an issue include California, New York, Texas and Florida.
Getting it right
Drop shipping can be a successful solution for sellers, but it can also add new layers of sales tax complexity. One way for businesses to make the most out of drop shipping and other innovative solutions is sales tax automation software such as Avalara AvaTax. AvaTax’s accuracy is 100% guaranteed, so you can be sure that you’re getting sales tax right no matter how your products are getting delivered.
For more on the rules for online retailers around drop shipping, download the whitepaper, Shipping and Not Handling Sales Tax.