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Sales Tax Responsibilities in Drop Shipping

Barkin Doganay · August 7, 2023 · 5 min read

Sales Tax Responsibilities in Drop Shipping

Dropshipping, a popular retail model, empowers sellers to make sales while having products shipped directly from suppliers or vendors. This eliminates the need for sellers to invest their funds in inventory, a departure from the traditional retail approach. However, the intricate aspect of dropshipping lies in the realm of sales tax responsibilities. This landscape underwent a significant transformation following the 2018 Wayfair vs. South Dakota case, resulting in sellers potentially establishing economic nexus in up to 44 states. In each state where nexus exists, sellers are obliged to register, collect, and remit sales tax.

Outlined below is an overview of the dropshipping model and the ensuing sales tax obligations.

Dropshipping necessitates vendors to request a resale certificate from sellers. This certificate serves as protection for vendors against imposing sales tax, given that the products are being sold for resale. Unfortunately, there isn't a universal resale tax certificate that satisfies every vendor's requirements.

Diverse state-specific resale exemptions exist, each with varying documentation criteria.

It becomes imperative to discern the specific certificates requested by each vendor.

Dropshipping involves three primary parties:

  • Consumer (buyer/customer)
  • Seller (retailer)
  • Vendor (shipper/manufacturer responsible for product delivery to customers)

Two pivotal transactions transpire:

  • Between the consumer and the seller
  • Between the seller and the vendor

The second transaction dictates the type of resale certificate mandated between the seller and the vendor.

Vendors might be registered in multiple states, including the 45 states with sales tax and the District of Columbia (D.C.).

Determining the appropriate tax rate hinges on identifying the sourced sale location. This is contingent upon the state in which the product is delivered to the customer (the "ship to" state).

Upon vendor registration to collect sales/use tax in a state, tax collection is mandatory for transactions delivered to that state. Exceptions apply when vendors accept a duly completed exemption/resale certificate in lieu of tax collection.

In essence, after vendors are registered to collect and remit sales tax in each state, they must either collect tax on taxable product sales or furnish an exemption certificate for the transaction.

Crucially, the exemption certificate must meet the acceptance criteria of the taxing state.

Challenge arises because sellers typically aren't registered in most states where vendors ship products. For instance, a seller using platforms like Shopify may possess economic nexus in 25 states, allowing registration for sales tax collection in those states, but not necessarily in the remaining 20 states where customers are based.

For proper documentation of sales for resale, the exemption certificate must satisfy the ship-to state's requirements. Failure to do so could result in the state not acknowledging the sale as exempt, leading the vendor (the one shipping the product) to levy sales tax. Notably, the customer's location doesn't impact the tax obligation.

Solution-wise, 36 states accept documentation without requiring seller registration if nexus is absent. In states where nexus exists, registration is assumed for sales tax collection and remittance. Various states accept differing forms of documentation.

Ten states (California, Connecticut, D.C., Florida, Hawaii, Louisiana, Massachusetts, Maryland, Mississippi, and Tennessee) typically demand seller registration to issue a valid resale certificate.

A strategic option in these states involves seller registration for sales tax. This entails collecting and remitting sales tax in these states upon acquiring a sales tax permit and resale certificate.

While compliance costs are incurred, they usually pale in comparison to paying vendor sales tax directly. The average sales tax rate of 8% exemplifies the potential expense that sellers would otherwise cover from their earnings.

In California, legal entities such as LLCs or corporations are subject to an annual $800 franchise tax fee and state income tax filing. These expenses, although significant, often prove more cost-effective than personally shouldering sales tax payments, especially given California's substantial market share.

Consider an instance where a seller possesses a resale certificate in one state (e.g., NJ). If a taxable item is drop-shipped to a state without nexus (where the seller isn't registered), and the vendor has nexus (Vermont), the vendor would levy sales tax. To circumvent this, a resale certificate for the vendor in Vermont is necessary.

An alternative approach exists, albeit with associated cautions.

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