Sales tax implications of drop shipping

There are a lot of advantages to drop shipping, which is why it might account for as much as 33 percent of ecommerce sales annually, according to Bloomberg. It’s more than just using a third party to fulfill your orders — you don’t even have to purchase inventory until you make a sale, you don’t have to store that inventory, and you don’t even have to worry about shipping products to customers.

The FBA model is similar in that Amazon ships orders for sellers; however, FBA requires you to maintain your own inventory at an Amazon warehouse, rather than purchase items from a manufacturer or supplier only after you make a sale. Many FBA businesses sell through other channels as well, however, and drop shipping can be an attractive option for those sales.

Drop shipping can also be a great way for businesses to minimize the risk of being stuck with a glut of unsold products, and enable many sellers to expand their offerings with niche or seasonal products that might not be practical for them to sell otherwise.

However, it also can increase risk in certain areas, too — you’re trusting another company to provide and ship products on your behalf, which can lead to issues with customer service, stock shortages, and more. Customers aren’t likely to blame the drop shipper, either; they ordered from you, after all.

Though drop shipping simplifies some business operations, it can complicate one that’s already confusing: sales tax. It’s hard enough to get that right when you’re fulfilling your own orders, let alone when a third party is managing your sales and shipments. Do you need to collect tax? Does the shipper? Do you both? And what happens when the different parties are in different states?

Before you dive into the world of drop shipping, be sure to understand your obligations and how to meet them.

Drop shipping sales tax Q&A

When does sales tax need to be collected on drop-shipping transactions?
There are several different drop-shipping scenarios that can result in a tax obligation:

• If you have nexus in the state where the sale occurs (in most cases, meaning where the item will be shipped), you collect sales tax from the customer.

• If you don’t have nexus in that state, but the drop shipper does, some states (including California, Connecticut, Florida, and Hawaii) require the drop shipper to collect sales tax, either from you or the customer. See the next question for more detail.

• If neither you nor the drop shipper have nexus where the sale occurs, the customer is responsible for paying use tax to their state or jurisdiction.

A few additional things to consider: If your product is exempt from sales tax, nobody needs to collect or pay sales and use tax, of course. And in most states, if you have the proper documentation as a reseller, you shouldn’t be charged sales tax on the transaction between you and the drop shipper. Many states will honor this documentation even if it’s from another state — for example, if your drop shipper is in New York and you have a resale certificate in Washington. Also, states that are members of the Streamlined Sales and Use Tax Use Agreement all accept the SST-certified exemption certificate.

What happens when the drop shipper is obligated to collect sales tax? They’re shipping the product to my customer, but I own the relationship.
This varies by state, too. In some states, you’re required to collect the sales tax at the time of purchase on behalf of the drop shipper and remit it in the appropriate state, even if you don’t have nexus there. In other states, the shipper is the one responsible for collecting from the customer. That means it’s important to know the rules for each state, not only to comply with the law, but also to avoid a situation where both you and the shipper charge sales tax to the customer. That’s not a good experience for anyone.

Can a state claim my business has nexus simply because I use a drop shipper located there?
In certain instances, yes. A number of states, such as California, New York, Texas, and Florida, maintain that out-of-state companies have created nexus if they use a drop shipper located in their state.

And to make the answers to the last two questions even more complex, the rules on taxable amounts can vary; in some states, the retail amount is taxable, while in others, it’s the wholesale price. In California, sales tax applies to either the retail price or the wholesale price plus 10 percent.

How do I keep all of this straight?
If you’re using a drop-shipping solution for your business, it’s probably worthwhile to invest in an automated solution for sales tax as well — that is, unless you want to try to keep up with the thousands of tax jurisdictions around the country, stay informed about ever-changing regulations, and also manage all of the records and files that go along with collecting and remitting tax.

Avalara can help. Whether you’re new to drop shipping or you’ve been using it for years, we’ve got solutions to streamline your sales tax compliance. That means you’ll have more time to focus on growing your business — and serving your customers.