by Scott Peterson
Drop shipping can be an option for online sellers, especially small businesses that don’t have the funds or space to stock inventory.
With drop shipping, sellers can take orders from customers and pass it on to their supplier, who handles fulfillment and shipment directly to the customer. In many ways, this is a win-win for all, but using drop shipping can create complexity when it comes to sales tax.
Know Your Nexus
As with any sales tax, 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, no matter how the item is delivered to the customer.
Beware: Your Supplier Could Have Nexus
Drop shipping can be tricky 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 usually only obligated to collect sales taxes on a sale if you have nexus in the customer’s state.
However, several states hold the supplier with nexus in that state responsible for collecting 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 vendor or provide an exemption certificate so that you don’t have to pay tax.
In most states, sales taxes only get 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 vendor 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 other documentation in a drop shipping situation.
In states that don’t recognize these, the seller may have to deal with some unexpected requirements. For example, in states like California which have stricter requirements for resale certificates, a seller may have to register with the state so they can provide a valid exemption certificate. By registering 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 satisfactory 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 our free whitepaper: “Shipping and Not Handling Sales Tax.”
About the Author
Scott Peterson is the Director of Government Affairs for Avalara. In his role, Scott leads Avalara’s effort to be the first name in sales tax automation.
Article reprinted from the Winter 2016 issue of Bellwether.
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