Drop Shipping and Sales Tax: A Simple Guide

Sales tax 101

In the U.S., all sellers (whether retailers or drop shippers) are required to collect sales tax if they have sales tax nexus in the state to which the item ships.

For example, Adam runs an online music store from Archer City, Texas, which means he has “nexus” in Texas and is required to collect sales tax from Texas buyers. If Adam sells a synthesizer to a buyer in Denton, Texas, he’s required to charge that buyer sales tax.

But if Adam sells that synth to a buyer in Kenner, Louisiana, Adam isn’t required to collect sales tax because he doesn’t have sales tax nexus in Louisiana.

However, things start to get more complicated when drop shipping is involved.
It’s important to note that in ecommerce transactions the “point of sale” is considered to be the buyer’s “ship to” address. It doesn’t matter where the buyer is located, only where the buyer takes possession of the item after it is shipped.

This means that you, as the buyer from your third-party vendor, may be responsible for paying sales tax if your vendor has nexus in your state.

Explain it to me like I’m five

Confused? That’s understandable. Sales tax has a tendency to make people feel lost! Let’s break it down with a few example scenarios.

Imagine that Ron Retailer sells a coffee cup to Bobby Buyer. Ron doesn’t have the coffee cup in his stock, so he purchases the cup from Debbie Drop Shipper, and has Debbie deliver the cup to Bobby.

In this case, Ron Retailer pays Debbie Drop Shipper (his supplier) for the cup, and Bobby Buyer pays Ron.

Who charges sales tax? Well, it can work out in a few different ways.

Scenario 1: Ron Retailer collects the sale tax from Bobby Buyer

Bobby Buyer is located in a state where Ron Retailer has sales tax nexus. In this case, Ron would be required to collect sales tax from Bobby. If Ron doesn’t have sales tax nexus in Bobby’s ship-to state, then he isn’t required to collect sales tax from her.

Scenario 2: Debbie Drop Shipper collects the sales tax from Ron Retailer

However, Debbie Drop Shipper may have sales tax nexus in the state where Bobby is located. Since Debbie is drop shipping the product to Bobby at her ship-to address, Debbie would be required to charge sales tax from the buyer, Ron Retailer, if Bobby is located in a state where Debbie has nexus.

Scenario 3: Ron Retailer provides Debbie Drop Shipper with a Resale Certificate

In this case, Ron has given proof to Debbie that she does not have to collect sales tax from him, because he is also a retailer. In this scenario, Debbie does not collect sales tax from Ron, even if Debbie has sales tax nexus in the state where Bobby Buyer is located. Keep reading for more on resale certificates.

It helps to remember that someone is responsible for collecting sales tax, and in some cases both Debbie Drop Shipper and Ron Retailer will be responsible for collecting sales tax.

(Still confused about drop shipping? We detail more drop shipping scenarios in this blog post.)

Resale certificates and drop shipping

A resale certificate allows a retailer to buy products to resell without paying sales tax on those products. As a retailer, you can present your resale certificate to your vendor to let them know that they aren’t required to collect sales tax from you.

In the case of Ron Retailer and Debbie Drop Shipper, if Ron presented his resale certificate to Debbie, she would know she didn’t have to collect sales tax from him, even when drop shipping on his behalf to a customer in one of the states where she has sales tax nexus.

There are a few important things retailers should know about resale certificates:

Resale certificates are only legally used when purchasing items for resale

While every U.S. state is a bit different when it comes to laws and regulations governing resale certificates, they can generally only be used to purchase items that you truly intend to resell, or use as a component part of an item intended for resale (i.e. wood that you will manufacture into furniture).

Not all vendors will accept resale certificates

Your vendor reserves the right not to accept your resale certificate. Mainly because it’s the vendor who is on the hook for unpaid sales tax should a resale certificate turn out to be fraudulent. Vendors may also not accept resale certificates because they don’t want to encourage resellers to buy their products. Target is a well-known example of a retailer that discourages the use of resale certificates.

Working with a drop shipper outside your state

In today’s global selling environment, there’s a strong chance you will use a drop shipper outside your state.

Thirty-six of the states with a sales tax allow your vendor to accept a resale certificate issued by any state. (Hint: In most cases a resale certificate is the same as your sales tax permit.)

However, in ten states you are required to register for a sales tax permit and collect sales tax from all buyers in that state in order to take advantage of the perks of having a resale certificate.

Further reading: How to Start a Dropshipping Business

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Collecting sales tax as a drop shipper can feel like an algebra problem, depending on the scenario.

If you’re feeling stuck, TaxJar’s software can help you get your sales tax filed properly, all online. If you still have lingering questions, you can speak with a vetted sales tax expert who can help you navigate drop shipping and sales tax.

This is a guest post by Jennifer Dunn from TaxJar, a service that makes sales tax reporting and filing simple for more than 10,000 online sellers.